CG

Unit 1
- Corporate or a Corporation is derived from the Latin term “corpus” which means a “body”.

- Governance means administering the processes and systems placed for satisfying stakeholder
expectation. The root of the word Governance is from ‘gubernate’, which means to steer.

- When combined, Corporate Governance means a set of systems, procedures, policies,

practices, standards put in place by a corporate to ensure that relationship with various
stakeholders is maintained in a transparent and honest manner and business is conducted
ethically.

- The phrase “corporate governance” describes “the framework of rules, relationships, systems
and processes within and by which authority is exercised and controlled within corporations. It
encompasses the mechanisms by which companies, and those in control, are held to account.”

- Corporate governance is the broad term used to describe the processes, customs, policies, laws
and institutions that direct the organizations and corporations in the way they act or
administer and control their operations.

- It works to achieve the goal of the organization and manages the relationship among the
stakeholders including the board of directors and the shareholders.

- Corporate governance means to steer an organization in the desired direction by determining

ways to take effective strategic decisions. It also deals with the accountability of the
individuals through a mechanism which reduces the principal-agent problem in the
organization.

- Corporate Governance has a broad scope. It includes both social and institutional aspects.
Corporate Governance encourages a trustworthy, moral, as well as ethical environment.

- In other words, the heart of corporate governance is transparency, disclosure, accountability

and integrity. It is to be borne in mind that mere legislation does not ensure good governance.
Good governance flows from ethical business practices even when there is no legislation.

- Good corporate governance promotes investor confidence, which is crucial to the ability of
entities listed to compete for capital. Good corporate governance is essential to develop added
value to the stakeholders as it ensures transparency which ensures strong and balanced
economic development. This also ensures that the interests of all shareholders (majority as well
as minority shareholders) are safeguarded. It ensures that all shareholders fully exercise their
rights and that the organization fully recognizes their rights.

Definitions
 1. Corporate Governance is “the conduct of business in accordance with shareholders’ desires,
which generally is to make as much money as possible, while conforming to the basic rules of
the society embodied in law and local customs.” - Noble Laureate Milton Friedman

2. “Corporate Governance is concerned with the way corporate entities are governed, as distinct
from the way business within those companies are managed. Corporate governance addresses
the issues facing Board of Directors, such as the interaction with top management and
relationships with the owners and others interested in the affairs of the company” - Robert Ian
(Bob) Tricker (who introduced the words corporate governance for the first time in his book in
1984)

3. “Corporate Governance is about promoting corporate fairness, transparency and accountability”

- James D. Wolfensohn (Ninth President World Bank)

4. “Corporate governance deals with laws, procedures, practices and implicit rules that determine
a company’s ability to take informed managerial decisions vis-à-vis its claimants - in particular, its
shareholders, creditors, customers, the State and employees. There is a global consensus about
the objective of ‘good’ corporate governance: maximising long-term shareholder value.” -
Confederation of Indian Industry (CII) – Desirable Corporate Governance Code (1998)

5. “Corporate Governance is the acceptance by management of the inalienable rights of

shareholders as the true owners of the corporation and of their own role as trustees on behalf of
the shareholders. It is about commitment to values, about ethical business conduct and about
making a distinction between personal and corporate funds in the management of a company.’”
- Report of N.R. Narayana Murthy Committee on Corporate Governance constituted by SEBI
(2003)

Salient advantages of Corporate Governance are stated hereunder:

1. Good corporate governance ensures corporate success and economic growth.

2. Strong corporate governance maintains investors’ confidence, as a result of which, company can
raise capital efficiently and effectively.

3. There is a positive impact on the share price.

4. It provides proper inducement to the owners as well as managers to achieve objectives that are
in interests of the shareholders and the organization.

5. Good corporate governance also minimizes wastages, corruption, risks and mismanagement.

6. It helps in brand formation and development.

7. It ensures organization is managed in a manner that fits the best interests of all.

NEED FOR CORPORATE GOVERNANCE

(a) Corporate Performance

(b) Enhanced Investor Trust

 (c) Better Access to Global Market

(d) Combating Corruption

(e) Easy Finance from Institutions

(f) Enhancing Enterprise Valuation

(g) Reduced Risk of Corporate Crisis and Scandals

(h) Accountability

ELEMENTS / SCOPE OF GOOD CORPORATE GOVERNANCE

1. Role and powers of Board - Good governance is decisively the manifestation of personal beliefs
and values which configure the organizational values, beliefs and actions of its Board. The board
is the primary direct stakeholder influencing corporate governance. Directors are elected by
shareholders or appointed by other board members and are tasked with making important
decisions, such as corporate officer appointments, executive compensation and dividend policy.
In some instances, board obligations stretch beyond financial optimization, when shareholder
resolutions call for certain social or environmental concerns to be prioritized. The Board as a
main functionary is primarily responsible to ensure value creation for its stakeholders. The
absence of clearly designated role and powers of Board weakens accountability mechanism and
threatens the achievement of organizational goals. Therefore, the foremost requirement of good
governance is the clear identification of powers, roles, responsibilities and accountability of the
Board, CEO, and the Chairman of the Board. The role of the Board should be clearly documented
in a Board Charter.

2. Clear and unambiguous legislation and regulations are fundamental to effective corporate
governance - Legislation that requires continuing legal interpretation or is difficult to interpret
on a day-to-day basis can be subject to deliberate manipulation or inadvertent misinterpretation.

3. Management environment - Management environment includes setting-up of clear objectives

and appropriate ethical framework, establishing due processes, providing for transparency and
clear enunciation of responsibility and accountability, implementing sound business planning,
encouraging business risk assessment, having right people and right skill for the jobs,
establishing clear boundaries for acceptable behaviour, establishing performance evaluation
measures and sufficiently recognizing individual and group contribution.

4. Board skills - To be able to undertake its functions efficiently and effectively, the Board must possess
the necessary blend of qualities, skills, knowledge and experience. Each of the directors should make
quality contribution to the organization’s policies, operations and management. A Board should have a
mix of the following skills, knowledge and experience: – Operational or technical expertise, commitment
to establish leadership; – Financial skills; – Legal skills; and – Knowledge of Government and regulatory
requirement.

5. Board appointments - To ensure that the most competent people are appointed on the Board, the
Board positions should be filled through the process of extensive search. A well-defined and open
procedure must be in place for reappointments as well as for appointment of new directors.
Appointment mechanism should satisfy all statutory and administrative requirements. High on the
priority should be an understanding of skill requirements of the Board particularly at the time of making
a choice for appointing a new director. All new directors should be provided with a letter of appointment
setting out in detail their duties and responsibilities.

6. Board induction and training - Directors must have a broad understanding of the area of operation of
the company’s business, corporate strategy and challenges being faced by the Board. Attendance at
continuing education and professional development programmes is essential to ensure that directors
remain abreast of all developments, which are or may impact on their corporate governance and other
related duties.

7. Board independence - Independent Board is essential for sound corporate governance. This goal may
be achieved by associating sufficient number of independent directors with the Board. Independence of
directors would ensure that there are no actual or perceived conflicts of interest. It also ensures that the
Board is effective in supervising and, where necessary, challenging the activities of management. The
Board needs to be capable of assessing the performance of managers with an objective perspective.
Accordingly, the majority of Board members should be independent of both the management team and
any commercial dealings with the company.

8. Board meetings - Directors must devote sufficient time and give due attention to meet their
obligations. Attending Board meetings regularly and preparing thoroughly before entering the
Boardroom increases the quality of interaction at Board meetings. Board meetings are the forums for
Board decision-making. These meetings enable directors to discharge their responsibilities. The
effectiveness of Board meetings is dependent on carefully planned agendas and providing relevant
papers and material to directors sufficiently prior to Board meetings.

9. Code of conduct - It is essential that the organization’s explicitly prescribed norms of ethical practices
and code of conduct are communicated to all stakeholders and are clearly understood and followed by
each member of the organization. Systems should be in place to periodically measure, evaluate and if
possible recognise the adherence to code of conduct.

10. Strategy setting - The objectives of the company must be clearly documented in a long-term
corporate strategy including an annual business plan together with achievable and measurable
performance targets and milestones.

11. Business and community obligations - Though basic activity of a business entity is inherently
commercial yet it must also take care of community’s obligations. Commercial objectives and community
service obligations should be clearly documented after approval by the Board. The stakeholders must be
informed about the proposed and ongoing initiatives taken to meet the community obligations.

12. Financial and operational reporting - The Board requires comprehensive, regular, reliable, timely,
correct and relevant information in a form and of a quality that is appropriate to discharge its function of
monitoring corporate performance. For this purpose, clearly defined performance measures - financial
and non-financial should be prescribed which would add to the efficiency and effectiveness of the
organisation. The reports and information provided by the management must be comprehensive but not
so extensive. The reports should be available to Board members well in advance to allow informed
decision-making. Reporting should include status report about the state of implementation to facilitate
the monitoring of the progress of all significant Board approved initiatives.

13. Monitoring the Board performance - The Board must monitor and evaluate its combined
performance and also that of individual directors at periodic intervals, using key performance indicators
besides peer review. The Board should establish an appropriate mechanism for reporting the results of
Board’s performance evaluation results.

14. Audit Committees - The Audit Committee is inter alia responsible for liaison with the management;
internal and statutory auditors, reviewing the adequacy of internal control and compliance with
significant policies and procedures, reporting to the Board on the key issues. The quality of Audit
Committee significantly contributes to the governance of the company.

15. Risk management - Risk is an important element of corporate functioning and governance. There
should be a clearly established process of identifying, analyzing and treating risks, which could prevent
the company from effectively achieving its objectives. It also involves establishing a link between risk-
return and resourcing priorities. Appropriate control procedures in the form of a risk management plan
must be put in place to manage risk throughout the organization. The plan should cover activities as
diverse as review of operating performance, effective use of information technology, contracting out and
outsourcing.

Accountability:

- Accountability refers to answer-ability or liability.

- Shareholders and investors are interested in who will responsible for which operation and liable
for when something goes wrong.

- And even when everything goes smoothly as expected, knowing that someone will be held
accountable for future mishaps increases shareholders’ confidence, which in turn increases their
desire to invest more.

- This applies from the staff all the way up to top leadership embracing Risk management within
defined formal appetite for risk.

- This also include fostering culture of compliance to create real and perceived believe that the
entity is operation within internal and external boundaries.

- Accountability is closely linked to transparency and involves holding company management and
the board of directors responsible for their actions and decisions.

- This includes ensuring that they act in the company's and its shareholders' best interests and
that they are held accountable for any breaches of laws, regulations, or ethical standards.

- An effective corporate governance framework includes mechanisms for reporting and addressing
any misconduct, conflicts of interest, or unethical behavior by company officials and for taking
appropriate actions to rectify any issues identified.

- Accountability is crucial to corporate governance as it ensures that companies are held

responsible for their actions and decisions.
 - It promotes transparency and integrity in business operations, fostering trust among
stakeholders. Companies need to be accountable for their financial performance, adherence to
laws and regulations, ethical conduct, and management of risks.

- When companies are transparent and accountable, they are more likely to gain the trust of
investors, customers, employees, and other stakeholders, which can positively impact their
reputation and long-term success.

Transparency:

- Transparency refers to clarity i.e. everything going in the organization should be crystal clear,
nothing to hide. Organization should provide timely accurate disclosure of information about all
activities in the organization such as financial situation, social and environmental factors,
performance etc.

- Transparency is a critical component of corporate governance because it ensures that all of

entity’s actions can be checked at any given time by an outside observer. This makes its
processes and transactions verifiable, so if a question does come up about a step, the company
can provide a clear answer.

- Transparency is another crucial pillar of corporate governance, as it ensures that companies

operate openly and transparently, with information accessible to stakeholders. Transparency
involves disclosing information about the company's financial performance, business operations,
risks, governance structure, and other relevant matters. This allows stakeholders to clearly
understand the company's activities, performance, and decision-making processes.

- Transparency and accountability are the foundation of corporate governance. Transparency

involves providing accurate and timely information about the company's financial performance,
business operations, risks, and opportunities. This can be achieved through regular financial
reporting, disclosure of material information, and clear communication channels between the
company and its stakeholders.

- A corporation must be open and willing to provide timely information on the company's
financial, social, and political position to shareholders, stakeholders, customers, and the general
public. A board demonstrates good corporate transparency with a functioning audit committee,
routine external audits, and objective, accurate yearly reports.

- Companies that are transparent in their operations and decision-making processes build trust
with their stakeholders, including shareholders, employees, customers, and the wider public.

- Corporate governance must include transparency since it makes sure that any action taken by a
firm may be reviewed at any moment by a third party. This verifies its transactions and
processes, enabling the organization to respond to inquiries regarding specific steps if they arise.

Fairness:

- Fairness is a crucial tenet of corporate governance because it guarantees that businesses treat all
their stakeholders fairly and equally, including shareholders, employees, clients, suppliers, and
 communities. Businesses should develop guidelines and procedures that encourage equity and
guard against prejudice, bigotry, and unjust treatment.

- This involves ensuring that every shareholder, regardless of their share count or influence, has an
equal opportunity to participate in the company's decision-making procedures, such as casting a
vote on crucial issues and electing directors.

- To protect the interests of all stakeholders, fairness also entails putting in place efficient
mechanisms for risk management, internal controls, and audit procedures. To ensure that
executive compensation, performance reviews, and board nominations are merit-based,
businesses should implement fair and transparent systems.

- Fairness means “treating all stakeholders equally and ensure their rights. The corporate
governance framework should protect shareholder rights and ensure the equitable treatment of
all stakeholders, including minority and foreign shareholders. Organization should respect the
right of shareholder and encourage them to exercise their rights.

Responsibility:

- Responsibility focuses on businesses acting in a socially and ecologically responsible way.

Businesses should consider how their decisions affect society, the environment, and future
generations. This entails implementing ethical and sustainable corporate practices, such as
minimizing environmental effects, fostering diversity and inclusion, upholding human rights, and
enhancing community well-being.

- Responsibility also entails interacting with stakeholders and responding to their issues and
demands. Companies should set up efficient communication channels with their stakeholders;
these include routine shareholder meetings and soliciting stakeholder feedback and input to
guide their decision-making.

- Companies should also be transparent about their social and environmental performance and
progress toward sustainability goals and be willing to be held accountable for their actions. This
pillar also entails an organization carrying out corporate social responsibility, which yields
enhanced community support, branding, and customer loyalty.

Independence:

- Independence means the right of taking decision without any influence. Good corporate
governance requires independence on the part of the top management of the corporation i.e.
the Board of Directors must be strong non-partisan body; so that it can take all decisions based
on business prudence.

- In progressing transparency it is important for non-direct actors to obtain confidence that that
executive actors are leading the entity towards per-defined intent and not using it for self and
obtain expert advisory on how applied approached can be improved.

- It is an ability to 'stand apart' from inappropriate influences and to be free of managerial

capture, to be able to make the correct and uncontaminated decision on a given issue. If, for
 example, an auditor is a longstanding friend of a client, the auditor may not be sufficiently
independent of the client.

- A company having good Corporate Governance and an effective Board of Directors attract
investors and ensure investment. Independence of the Board is critical to ensure that the board
fulfills its role objectively and holds the management accountable to the company.

History of Corporate Governance –

- The history of corporate governance is long, rich and packed with twists and turns. It’s a topic
that touches on managerial accountability, board structure and shareholder rights — including
both periods of shareholder passivity and shareholder power.

- Governance began with the rise of corporations, dating back to the East India Company, the
Hudson’s Bay Company, the Levant Company and other major chartered companies during the
16th and 17th centuries.

- While the concept of corporate governance has existed for centuries, the name didn’t come
into vogue until the 1970s.

- The United States was the only country using the term at the time.

- The balance of power and decision-making between board directors, executives and
shareholders has been evolving for centuries.

- The issue has been a hot topic among academic experts, regulators, executives, and investors,
making corporate governance history critical to understanding why corporate governance is so
important.

World War II - 1980s: Corporate growth emphasizes developing corporate governance - Post-World
War II

- After World War II, the United States experienced strong economic growth, which strongly
impacted the history of corporate governance. Corporations were thriving and proliferating.
Managers primarily called the shots and expected board directors and shareholders to follow. In
most cases, they did. This was an interesting dichotomy since managers highly influenced the
selection of board directors. Unless it came to matters of dividends and stock prices, investors
tended to steer clear of governance matters.

1970s

- In the 1970s, corporate governance history began to change as the Securities and Exchange
Commission (SEC) brought the issue of corporate governance to the forefront when they
brought a stance on official corporate governance reforms.

- In 1976, the term corporate governance first appeared in the Federal Register, the official journal
of the federal government.

- In the 1960s, the Penn Central Railway diversified by starting pipelines, hotels, industrial parks
and commercial real estate. Penn Central filed for bankruptcy in 1970, and the public scrutinized
the board.
 - In 1974, the SEC brought proceedings against three outside directors for misrepresenting the
company’s financial condition and a wide range of misconduct by Penn Central executives.
Around the same time, the SEC caught on to widespread payments by corporations to foreign
officials over falsifying corporate records.

- Corporations formed audit committees and appointed more outside directors during this era. In
1976, the SEC prompted the New York Stock Exchange (NYSE) to require each listed corporation
to have an audit committee composed of all independent board directors, and they complied.

- Advocates pushed to get governance right by requiring audit committees, nomination

committees, compensation committees and only one managerial appointee.

The 1980s: A corporate governance reform counter-reaction

- The 1980s ended the 1970s movement for corporate governance reform due to a political shift
to the right and a more conservative Congress. This era brought much opposition to
deregulation, another significant change in the history of corporate governance.

- Lawmakers advanced The Protection of Shareholders’ Rights Act of 1980, but it stalled in
Congress.Debates on corporate governance focused on a new project called the Principles of
Corporate Governance by the American Law Institute (ALI) in 1981.

- The NYSE had previously supported this project but changed their stance after they reviewed the
first draft. The Business Roundtable also opposed ALI’s attempts at reform. Advocates for
corporations felt they were strong enough to oppose regulatory reform outright without the
restrictive ALI-led reforms.

- Businesses had concerns about some of the issues in Tentative Draft No. 1 of the Principles of
Corporative Governance. The draft recommended that boards appoint mostly independent
directors and establish audit and nominating committees. Corporate advocates were concerned
that if companies implemented these measures, it would increase liability risks for board
directors.

- Law and economic scholars also heavily criticized the initial ALI proposals. They expressed
concerns that the proposals didn’t account for the pressures of the market forces and didn’t
consider empirical evidence. In addition, they didn’t believe that fomenting litigation would
serve a purpose in advancing effective corporate governance.In the end, the final version of
ALI’s Principles of Corporate Governance was so watered down that it had little impact on the
history of corporate governance by the time it was approved and published in 1994. Scholars
maintained that market mechanisms would keep managers and shareholders aligned.

The ‘Deal Decade’ leads to shareholder activism

- The 1980s was also referred to as the ‘Deal Decade.’ Institutional shareholders grabbed more
shares, which gave them more control. They stopped selling out when times got tough.
Executives went on the defensive and struck deals to prevent hostile takeovers.

- State legislators countered takeovers with anti-takeover statutes at the state level. That,
combined with an increased debt market and an economic downturn, discouraged merger
 activity. The Institutional Shareholder Services (ISS) was formed to help with voting rights.
Shareholders fought with legal defenses, but judges often favored corporate decisions when
outside directors supported board decisions. Investors started to advocate for more independent
directors and to base executive pay on performance rather than corporate size.

2008: Financial crisis changes corporate governance history

- By 2007, banks had been taking excessive risks, and there was growing concern about a possible
collapse of the world financial system. Governments sought to prevent fallout by offering
massive bailouts and other financial measures.

- The collapse of the Lehman Brothers Bank developed into a major international banking crisis,
which became the worst financial crisis since the Great Depression in the 1930s. Congress
passed the Dodd-Frank Wall Street Reform and Consumer Act in 2010 to promote economic
stability in the United States, a significant milestone in corporate governance history.

2010s: Corporate governance surges as risks are on the rise

- The fallout from the financial crisis placed a heavier focus on best practices for corporate
governance principles throughout the 2010s. Boards of directors felt more pressure than ever
before to implement good governance practices like transparency and accountability. Strong
governance principles encouraged corporations to have a majority of independent directors and
well-composed, diverse boards.

- Advancements in technology improved efficiency in governance and created new risks as

well. Data breaches were a new and genuine concern for corporations. The first targets were
banks and financial institutions. As these institutions have bolstered the security measures in
their governance framework, hackers have turned their efforts to smaller corporations within
various industries, including governments.

2020s: Global economic uncertainty rattles stakeholders — and the board room

- Uncertainty has so far characterized the 2020s, a decade that will surely go down in the history
of corporate governance. Kicked off by the COVID-19 pandemic and the subsequent breakdown
of the supply chain, 2020 pushed many Americans to question the purpose of corporations.
Global geopolitics like the war in Ukraine and the Israel-Palestine conflict have only further
galvanized consumers to press corporations to make a stand.

- Many corporations increasingly turned to a stakeholder model of corporate governance, which

equally weighs and prioritizes the interests of all people affected by corporate activity —
investors, employees, and the communities in which they operate. Consumers’ focus
on environmental, social, and governance (ESG) partly drove that shift, but so did regulations
like the SEC’s new Climate Disclosure Rules, which up the ante on accountability.

- The 2023 adoption of the universal proxy rules also gave shareholders a new voice in the
boardroom. That rule put shareholders’ director nominations on the same proxy card as the
corporations’ nominations, affirming shareholders’ power to influence decision-making.
- The Organization for Economic Co-operation and Development (OECD) is an international
organization focused on building policies that enhance global well-being and prosperity. The
OECD collaborates with governments, policy makers, and citizens to develop evidence-based
international standards and solutions for a variety of socio-economic and environmental issues.
By fostering cooperation and sharing data, the OECD helps shape effective policies in areas such
as economic performance, job creation, education improvement, and international tax evasion
prevention.
-
- OECD Core Principles of Corporate Governance
-
- The OECD Principles offer guidelines to support transparent and responsible corporate
governance. Key principles include:
-
- 1. Ensuring an Effective Corporate Governance Framework:
- • The corporate governance framework should encourage fair and transparent
markets, efficient resource allocation, and consistency with the rule of law.
- • It should promote economic performance, market integrity, and transparency,
with regulatory requirements that are enforceable and align with the rule of law.
- • Supervisory and regulatory authorities must have clear authority, resources, and
integrity to enforce rules objectively and transparently.
- • Cross-border cooperation is encouraged to facilitate information exchange and
support consistent governance standards globally.
- 2. Rights and Equitable Treatment of Shareholders:
- • The framework should protect and facilitate shareholder rights, treating all
shareholders equitably, including minority and foreign shareholders, with access to remedies if
their rights are violated.
- • Basic shareholder rights should include:
- 1. Secure methods of ownership registration.
- 2. The ability to transfer shares.
- 3. Timely access to relevant corporate information.
- 4. Participation and voting in general meetings.
- 5. Election and removal of board members.
- 6. A right to share in the company’s profits.
-

- Here’s a summary of additional OECD Principles of Corporate Governance

which elaborate on shareholder rights, the role of stakeholders, and the
responsibilities of institutional investors:
-
- 2. Rights and Equitable Treatment of Shareholders
(Continued)
-
- • Participation in Key Decisions: Shareholders should be
informed and able to approve significant corporate changes, such as:
- • Amendments to governing documents,
- • Authorization of new shares,
- • Major transactions like asset sales effectively amounting to a
sale of the company.
- • General Meetings:
- • Shareholders should have access to timely, detailed information
about meeting logistics and agenda items.
- • Voting procedures should ensure fairness, transparency, and
minimal barriers to participation, including the ability to vote in person or
remotely.
- • Shareholders should be able to question the board, add items to
the agenda, and propose resolutions.
- • Participation in governance decisions, such as board
nominations and executive remuneration, should be facilitated.
- • Equal Treatment: Shareholders within the same class should
have equal rights. Capital structures granting disproportionate control must
be disclosed and subject to approval if they alter existing rights.
- • Related-Party Transactions: These should be managed to
avoid conflicts of interest, and board members must disclose any material
interests in relevant transactions.
- • Protection of Minority Shareholders: Measures should be in
place to protect minority shareholders from potential abuses by controlling
shareholders, with effective means of redress available.
- • Corporate Control: Markets for corporate control should
operate transparently. Rules around mergers and asset sales must be clear,
and anti-takeover mechanisms should not shield boards from accountability.
-
- 3. Institutional Investors, Stock Markets, and Intermediaries
-
- • Disclosure by Institutional Investors: Investors with fiduciary
responsibilities should reveal their voting policies and conflict-of-interest
management practices, aligning votes with beneficial owners’ directions.
- • Conflict Management: Entities such as proxy advisors, analysts,
and rating agencies must disclose conflicts of interest to maintain the
integrity of their advice.
- • Prohibitions on Market Abuse: Insider trading and market
manipulation should be strictly prohibited and enforced.
- • Cross-Listing Disclosure: Companies listed outside their
jurisdiction must disclose applicable governance standards transparently,
especially in cross-listing scenarios.
- • Price Discovery: Stock markets should ensure fair price
discovery, enhancing governance through efficient market functioning.
-
- 4. The Role of Stakeholders in Corporate Governance
-
- • Stakeholder Rights: Legal or agreed-upon stakeholder rights
should be respected, with mechanisms for redress available if rights are
violated.
- • Employee Participation: Frameworks should allow for
employee involvement in governance where relevant.
- • Access to Information: Stakeholders engaged in governance
should receive reliable, timely information.
- • Whistleblower Protections: Stakeholders, including
employees, must be able to report unethical practices without fear of
retaliation.
- • Complementary Insolvency Framework: A robust insolvency
system and creditor rights enforcement should support the governance
framework.
-
- These principles promote a balanced, transparent, and fair corporate
environment where shareholders’ rights are protected, stakeholders’ roles
are respected, and institutions are held accountable, fostering a stable and
responsible corporate governance structure.
-
-

- 5. Here is a summary of the OECD Principles on Disclosure and

Transparency and Board Responsibilities:
-
- 5. Disclosure and Transparency
-
- • Material Information Disclosure: Companies must disclose
key information accurately and on time, including:
- • Financial results, objectives, and non-financial data.
- • Share ownership, including beneficial owners and voting rights.
- • Remuneration for board members and executives.
- • Board member details (e.g., qualifications, selection, other
directorships, independence status).
- • Related-party transactions and foreseeable risks.
- • Employee and stakeholder issues.
- • Governance structures and any corporate governance codes or
policies.
- • Standards for Information: High-quality standards for
accounting and financial and non-financial reporting should be met.
- • Annual Audit: An independent, qualified auditor must conduct
an annual audit, providing objective assurance that financial statements fairly
represent the company’s position.
- • Auditor Accountability: External auditors should act with due
care and are accountable to shareholders and the company.
- • Information Accessibility: Information should be accessible
equally, timely, and cost-efficiently to all stakeholders.
-
- 6. Responsibilities of the Board
-
- • Duties of the Board:
- • Strategic Guidance: Guide corporate strategy, review risk
management policies, monitor business plans, set performance goals, and
oversee significant expenditures and acquisitions.
- • Governance Practices: Review and enhance governance
practices as needed.
- • Executive Oversight: Oversee selection, compensation, and
succession planning for key executives.
- • Remuneration Alignment: Ensure executive and board pay
aligns with the company’s long-term interests.
- • Board Nomination: Facilitate a transparent board nomination
and election process.
- • Conflict Management: Manage potential conflicts of interest,
including misuse of assets or related-party abuses.
- • Financial Reporting Integrity: Maintain the integrity of
accounting and financial systems, ensure risk management, compliance, and
control mechanisms.
- • Disclosure Oversight: Oversee disclosure processes and ensure
effective communication.
- • Ethical Standards and Stakeholder Interests: Boards should
uphold high ethical standards and consider the interests of all stakeholders.
- • Fair Treatment: In cases where decisions impact different
shareholder groups, the board should act fairly.
- • Independent Judgment:
- • Non-executive directors should be included to manage areas
with conflicts of interest, such as financial reporting, executive nomination,
and remuneration.
- • Committees (e.g., audit, risk management, and remuneration)
should be set up when relevant, with clear mandates and procedures
disclosed.
- • Commitment and Evaluation: Board members should be
committed to their roles and regularly evaluated to ensure the right skills mix
and competencies.
- • Access to Information: Board members should have access to
relevant, accurate, and timely information to fulfill their responsibilities
effectively.
- • Employee Representation: If employees are represented on
the board, they should receive adequate information and training to
contribute effectively to board activities and decision-making.
-
- These principles aim to ensure transparency, fair shareholder treatment, and
accountable board practices, ultimately supporting effective corporate
governance and long-term company success.
-
Unit 3
- Necessity of Corporate Governance Committees
-
- Evolution of Corporate Governance Guidelines:
-
- • Corporate governance guidelines in India have developed
significantly since 1998, driven by efforts from the Ministry of Corporate
Affairs (MCA) and SEBI.
- • Indian corporate governance standards are highly regarded
globally, encompassing rules for board responsibilities, financial and non-
financial disclosures, and transparency in management’s communication with
stakeholders.
-
- Lessons from Corporate Misconduct:
-
- • Despite strong governance frameworks, corporate misconduct
can still occur, as seen in cases like Enron and WorldCom in the US and the
Satyam scandal in India.
- • The Satyam scandal in 2008, while an isolated case, underscored
the need to re-evaluate corporate governance norms and encourage
voluntary measures to prevent similar issues.
-
- Role of the Confederation of Indian Industry (CII):
-
- • Since 1998, the CII has promoted voluntary corporate
governance standards, publishing a code that outlined best practices for listed
companies.
- • Many of these voluntary recommendations became mandatory
under SEBI’s Kumar Mangalam Birla Committee Report and were
incorporated into Clause 49 of the Listing Agreement.
- • CII emphasizes the importance of going beyond legal
requirements to build reputational and stakeholder value, cautioning against
overregulation and advocating for a balance of legal frameworks and
voluntary adherence.
-
- Key Corporate Governance Recommendations (CII Code)
-
- 1. Board of Directors:
- • Have a single, efficient board that maximizes long-term
shareholder value.
- • Listed companies with a turnover of Rs. 100 crores or above
should have independent, non-executive directors:
- • At least 30% if the Chairman is a non-executive director.
- • At least 50% if the roles of Chairman and Managing Director are
held by the same person.
- 2. Limit on Directorships:
- • A single individual should not hold directorships in more than
10 listed companies to prevent conflicts of interest and promote dedicated
oversight.
- 3. Role of Non-Executive Directors:
- • Non-executive directors should actively participate in board
decisions, have specific roles (e.g., on audit committees), and possess basic
financial literacy to effectively contribute to the company’s governance.
- 4. Compensation for Non-Executive Directors:
- • Non-executive directors should receive a commission above
sitting fees to encourage dedicated contributions. The current standard is 1%
of net profits (if the company has a managing director) or 3% (if not).
- 5. Attendance and Reappointment:
- • Attendance records of directors should be disclosed. Directors
missing 50% or more meetings should not be reappointed, except under
explicit mention in the reappointment resolution.
- 6. Key Information for Board Reporting:
- • Boards should receive regular, comprehensive reports,
including:
- • Annual and capital budgets, manpower and overhead budgets,
quarterly results, and internal audit reports.
- • Notices from revenue authorities, incidents of theft or
dishonesty, serious accidents, and environmental issues.
- • Default on public deposits or secured loans, any significant
liability claims, substantial transactions (e.g., intellectual property), and joint
ventures.
- • Recruitment and compensation details for senior officers,
updates on labor issues, and foreign exchange exposure management.
-
- These governance guidelines are aimed at enhancing board effectiveness,
promoting transparency, and building robust internal controls that uphold
investor trust and sustainable business growth.
-
-
-
-
- 8. Key Recommendations from the Kumar Mangalam Birla
Committee on Corporate Governance
-
- Purpose and Scope
-
- • Committee Formation: SEBI set up this committee in 1999,
chaired by Kumar Mangalam Birla, to elevate corporate governance standards
in India.
- • Governance Pillars: The committee emphasized accountability,
transparency, and equitable treatment for stakeholders.
- • Categories: Recommendations were split into mandatory
(essential, enforceable) and non-mandatory (desirable, requiring legal
changes).
- • Application: All listed companies and specific entities under
other statutes, like banks and insurance companies, must follow these
standards as applicable.
-
- Mandatory Recommendations
-
- 1. Board Composition:
- • The board should include at least 50% non-executive directors.
- • An optimal balance of executive and non-executive directors is
essential.
- 2. Audit Committees:
- • The audit committee should have a minimum of three non-
executive directors, with the majority being independent and at least one
with finance and accounting knowledge.
- • Powers include investigating any board-related activity, seeking
information from employees, obtaining external advice, and inviting outside
experts when necessary.
- • The committee should oversee the financial reporting process,
approve the selection and fees of external auditors, and review annual
financial statements.
- 3. Non-Executive Director Remuneration:
- • The board should decide on the remuneration of non-executive
directors, with clear disclosures in the annual report on all aspects of the
compensation package.
- 4. Board Meetings:
- • Boards should meet at least four times annually, with a
maximum gap of four months between meetings.
- 5. Management and Financial Disclosures:
- • Management should disclose all material financial and
commercial transactions where they have a personal interest that could
conflict with the company’s interests.
- • A “Management Discussion and Analysis” report should be
included in the annual report.
- 6. Shareholder Information:
- • Companies should provide resumes, functional expertise, and
details on other board memberships when appointing or reappointing
directors.
- • A dedicated board committee, led by a non-executive director,
should address shareholder complaints.
- 7. Share Transfer Process:
- • Share transfer authority should be delegated to an officer,
committee, or transfer agent, ensuring transfers are processed at least bi-
weekly.
- 8. Corporate Governance Compliance:
- • Companies must highlight non-compliance of mandatory
recommendations, with reasons, and disclose the extent of adoption of non-
mandatory recommendations.
- • An auditor-certified compliance report on mandatory
recommendations should be attached to the annual directors’ report and sent
to stock exchanges.
-
- Additional Provisions
-
- 1. Audit Committees in Listed Companies:
- • Companies with a turnover of over Rs.100 crores or paid-up
capital of Rs.20 crores should set up an Audit Committee within two years.
- • Committees should consist of at least three non-executive
directors with knowledge of finance and company law.
- 2. Financial Disclosure and Internal Audit:
- • Companies must provide high-low monthly share price data,
details on business segments above 10% of turnover, and a comprehensive
breakdown of segment performance.
- • Listed companies must establish internal audit departments or
engage external auditors by 1998-99 for effective oversight.
- 3. Disclosure for GDR-Equivalent Issues:
- • Companies with Rs.20 crore or more paid-up capital must
provide the same level of disclosure for domestic issues as required for Global
Depository Receipts (GDR).
- 4. Credit Rating Transparency:
- • If multiple credit ratings are obtained, all must be disclosed in
the prospectus.
- 5. Restriction on Defaulting Companies:
- • Companies that default on fixed deposits cannot accept new
deposits, make intercorporate loans, or declare dividends until the default is
rectified.
-
-
- Here’s a summary of the key points and recommendations from the listed
committees on corporate governance in India:
-
- 1. Kumar Mangalam Birla Committee (1999)
-
- • Board Structure: At least 50% non-executive directors; audit
committees should have three non-executive members, with a majority of
them independent.
- • Audit Committees: Empowered to investigate and have access
to external resources; audit committees should review financials, auditor
appointments, and financial reporting.
- • Transparency in Remuneration: Disclosure of directors’
remuneration, incentives, and stock options.
- • Meetings and Disclosures: Board meetings at least quarterly;
disclosure on conflicts of interest, major transactions, and director
backgrounds.
- • Shareholder Engagement: Non-executive chairpersons may
maintain an office at the company’s expense; committees to address
shareholder complaints and expedite share transfers.
-
- 2. Narayana Murthy Committee (2003)
-
- • Corporate Board Responsibilities: Boards should aim for
company growth, uphold reputations, manage risks, set KPIs, and ensure
regulatory compliance.
- • Director Independence: Boards to include skilled, independent
directors who undergo annual training and evaluation; chairman assessed by
top investors.
- • Compensation Transparency: Clear, equitable management
compensation policies, linking incentives to long-term performance.
- • Whistleblower Protection: Whistleblowers to be protected
from retaliation; independent investigation of top management when
necessary.
- • Information Disclosure: Shareholders should have full access
to investigation information; avoid selective disclosures.
-
- 3. CII Task Force on Corporate Governance - Naresh Chandra
(2008-09)
-
- • Board of Directors: Emphasis on non-executive and
independent directors, audit and other board committees, and scrutiny of
significant related-party transactions.
- • Auditors’ Independence: Recommendation for rotating audit
partners to maintain auditor independence.
- • Regulatory Enforcement: Suggested standards for regulatory
agencies to ensure effective enforcement.
- • Institutional Role: Institutional investors and the media
encouraged to actively participate in enforcing corporate governance.
-
- Each report emphasizes accountability, transparency, and fairness as pillars
of corporate governance, aiming to improve the integrity of India’s corporate
sector.
-
- The corporate governance recommendations by various committees aim to
strengthen board oversight, transparency, accountability, and shareholder
rights. Here’s a breakdown of key points from each:
-
- Recommendations for Voluntary Adoption:
-
- 1. Board of Directors:
- • Nomination and Remuneration Committees: Suggested to
comprise a majority of independent directors to minimize conflicts.
- • Fixed Remuneration for NEDs and Independent Directors:
Encourages fair compensation that isn’t solely linked to company profits.
- • Separation of Chairman & CEO Roles: Recommended to support
balance and independence in leadership.
- 2. Audit Oversight:
- • Limits on Auditor Revenue: No more than 10% of revenues
should come from a single client.
- • Rotation of Audit Partners: Rotating partners every six years
with a cooling period to ensure objectivity.
- • Auditor Liability: Disclosure of firm net worth and liability limits.
- 3. Governance Mechanisms:
- • Whistleblower Policy: Protection against retaliation with direct
access to the audit committee chair.
- • Risk Management: Regular risk assessments and documentation
as a board responsibility.
- 4. Shareholder Rights and Media:
- • Shareholder Activism: Encourages active oversight of corporate
conduct.
- • Media’s Role: Emphasizes the importance of analytical, ethical
reporting in financial media.
-
- Narayan Murthy Committee (2003):
-
- • Emphasized transparency, fairness, and accountability in audit
practices, risk management, and remuneration of directors.
- • Key recommendations included creating competent boards,
ensuring management accountability, and having an independent audit
process to detect risks and governance deficits.
-
- J. J. Irani Committee (2004-05):
-
- • Stressed a legal framework conducive to economic reforms with
safeguards for stakeholder interests.
- • Recommended internal controls for public companies, adequate
disclosure, and shareholder involvement in decision-making, especially
regarding executive remuneration and financial reporting quality.
-
- CII Task Force (Naresh Chandra, 2008-09):
-
- • Advocated for board independence, rigorous auditing standards,
enhanced whistleblower protections, and risk management frameworks.
- • Suggested clear guidelines on the media’s responsibility in
corporate governance.
-
- Each of these sets of recommendations reflects a deepening focus on ethical,
well-regulated, and transparent corporate practices aimed at protecting
investors and other stakeholders while enabling companies to operate
efficiently and fairly within evolving market dynamics.
-
-
-
- The Kotak Committee on Corporate Governance, established by SEBI in
2017 and led by Uday Kotak, proposed numerous recommendations aimed at
aligning Indian corporate governance norms with global best practices while
 addressing India’s unique business environment. Below is an outline of the
committee’s key recommendations:
-
- 1. Board Composition and Independence
-
- • Separation of Chairman and MD/CEO Roles: For listed
companies with over 40% public shareholding, the roles of the chairman and
managing director/CEO should be separate, with the chair limited to non-
executive directors.
- • Board Size and Diversity: The minimum board strength should
be six members, including at least one woman as an independent director.
Listed companies should hold at least five board meetings per year.
- • Independent Directors: Half of the board members in listed
companies should be independent directors. Any non-executive directors
over 75 years old would require approval from public shareholders.
- • Minimum Remuneration for Independent Directors:
Independent directors should receive at least Rs 5 lakh annually, with a
sitting fee of Rs 20,000-50,000 per meeting.
-
- 2. Enhanced Governance Practices
-
- • Board Committees: Top-500 listed companies should have a
dedicated risk management committee focused on cyber security and a
separate information technology committee for digital initiatives.
- • Audit Committee and Disclosure Standards: The role of the
Audit, Nomination, and Remuneration Committees should be expanded to
include broader oversight. Disclosure of auditors’ credentials, audit fees,
reasons for auditor resignation, and enhanced information on the
expertise/skills of directors are required.
- • Evaluation Practices: Effective board evaluation processes
should be implemented, and succession planning and risk management
discussions should occur annually.
-
- 3. Shareholder and Stakeholder Engagement
-
- • Shareholder Meetings and Webcast: Top 100 companies by
market capitalization should webcast their shareholder meetings. All listed
firms must publish cash flow statements biannually and provide quarterly
consolidated earnings disclosures.
- • Voting and Participation in RPTs: Related parties should be
allowed to vote against related party transactions (RPTs), and disclosures
regarding RPTs must be more comprehensive.
-
- 4. Transparency in Financial Disclosures
-
- • Credit Ratings: An updated list of all credit ratings should be
readily accessible for stakeholders.
- • Use of Funds from Preferential Issues: Disclosures are
required for the utilization of funds raised through preferential issues.
- • Quarterly Results: From FY 2019-20, mandatory quarterly
consolidated results disclosures are required.
-
- 5. Subsidiary Oversight and Secretarial Audit
-
- • Subsidiaries: Listed companies must adhere to enhanced
governance obligations for their subsidiaries, including mandatory secretarial
audits for listed entities and their significant unlisted subsidiaries.
-
- 6. Additional Recommendations
-
- • Enhanced Eligibility Criteria for Independent Directors:
Expanding the criteria for individuals to qualify as independent directors.
- • Remuneration Transparency for Promoter Directors: Public
shareholder approval is required for executive directors from promoter
families if their remuneration exceeds Rs 5 crore or 2.5% of net profits, or if
multiple directors’ total remuneration surpasses 5% of net profits.
-
- These recommendations focus on strengthening transparency, accountability,
and investor protection while addressing challenges unique to the Indian
market, such as concentrated ownership and family-led businesses. The
Kotak Committee’s initiatives ultimately aim to foster a corporate governance
culture that balances regulatory oversight with effective board autonomy.
Unit 4
- Stewardship theory holds that people are intrinsically motivated to accomplish the work they
have been given by others and by organizations.

- Government service, or stewardship of state resources, ensures that state resources are
managed and protected properly and environmentally.

- In addition to building legitimacy and protecting and generating critical revenue for essential
services, protecting and managing state resources can also have positive effects.

- According to stewardship theory, human beings’ involvement in management projects is

motivated by the goal of motivating them to accomplish their objectives.

- Agency theory is an essential element of corporate governance theories with moral hazard
implications

- In general, governance refers to a process of decision making, whereas stewardship describes

the type of activity undertaken.

- When an item such as capacity or development or transparency, from a larger set of policies, is
pursued as good stewardship or a good form of governance, it may be considered as such

- Its purpose is to provide shareholder satisfaction with governance in a proper fashion.

- Investors of a more open-ended nature in a similar manner to the UK Corporate Governance

Code will be more accountable to their clients and beneficiaries with the UK Stewardship Code
as well.

- In the steward theory, shareholders are protected and maximized in their wealth when their
firms perform well.

- Registering a shareholder and working to protect and profit them are steward employees at
their companies. When organizational success is achieved, a steward gets satisfied and
motivated.

- An example of a stewardship model of corporate governance might include a business focused

on environmental concerns, where the company believes it should operate with as little impact
as possible on the earth.

- The Coca-Cola Company, which uses huge amounts of water for its products, for example, has
committed to being good stewards of water resources.

- A steward is defined as someone who protects and takes care of the needs of others.

- Under the stewardship theory, company executives protect the interests of the owners or
shareholders and make decisions on their behalf.

- Their sole objective is to create and maintain a successful organization so the shareholders
prosper. Firms that embrace stewardship place the CEO and Chairman responsibilities under one
executive, with a board comprised mostly of in-house members.
 - This allows for intimate knowledge of organizational operation and a deep commitment to
success.

Effects On Business

• A company committed to a higher purpose will draw clients who share that same purpose.

• However, if the owners talk about stewardship or social responsibility in its corporate
governance, the customers carefully weigh this against how the company truly operates.
Discrepancies between talk and action alienate the client base.

Effects On Employees

• Employees can tell fairly quickly if a company’s stewardship stance translates into how they’re
treated. Workers may have higher expectations than they would if an employer operates under a
pure profit motive.

• However, employees who hold to the same vision tend to stick around and work hard to
achieve the company’s goals even if compensation is not as much as they can get elsewhere. A
solid sense of stewardship improves company morale when the workers feel they’re part of
something bigger.

Effects On Clients

• Because people are often polarized in their political beliefs, it's important to review consumer
stewardship theory strengths and weaknesses.

• Some of your customers will want to feel like they’re part of something, and will stay with a
stewardship-driven business even if its price for goods or services is higher.

- the stewardship theory is a theory that managers, left on their own, will act as responsible
stewards of the assets they control, and describes the existence of a strong relationship between
satisfaction and organizational success.

- This theory was introduced by Donaldson and Davis (1989).

- Under the stewardship theory, company executives protect the interests of the owners or
shareholders and make decisions on their behalf. Their sole objective is to create and maintain
a successful organization so the shareholders prosper.

UK Corporate Governance brought out through Stewardship theory

- The Financial Reporting Council - The FRC’s mission is to promote transparency and integrity in
business.

- The FRC sets the UK Corporate Governance and Stewardship Codes and UK standards for
accounting and actuarial work;

- monitors and takes action to promote the quality of corporate reporting;

- and operates independent enforcement arrangements for accountants and actuaries.

 - As the Competent Authority for audit in the UK the FRC sets auditing and ethical standards and
monitors and enforces audit quality

- The first version of the UK Corporate Governance Code (the Code) was published in 1992 by
the Cadbury Committee.

- It defined corporate governance as ‘the system by which companies are directed and
controlled. Boards of directors are responsible for the governance of their companies.

- The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy
themselves that an appropriate governance structure is in place.’

- Successful and sustainable businesses underpin our economy and society by providing
employment and creating prosperity.

- To succeed in the long-term, directors and the companies they lead need to build and maintain
successful relationships with a wide range of stakeholders. These relationships will be
successful and enduring if they are based on respect, trust and mutual benefit.

- Accordingly, a company’s culture should promote integrity and openness, value diversity and be
responsive to the views of shareholders and wider stakeholders. Over the years the Code has
been revised and expanded to take account of the increasing demands on the UK’s corporate
governance framework.

- The principle of collective responsibility within a unitary board has been a success and –
alongside the stewardship activities of investors – played a vital role in delivering high
standards of governance and encouraging long-term investment.

- At the heart of this Code is an updated set of Principles that emphasise the value of good
corporate governance to long-term sustainable success.

- By applying the Principles, following the more detailed Provisions and using the associated
guidance, companies can demonstrate throughout their reporting how the governance of the
company contributes to its long term sustainable success and achieves wider objectives.

- Achieving this depends crucially on the way boards and companies apply the spirit of the
Principles.

- The Code does not set out a rigid set of rules; instead it offers flexibility through the
application of Principles and through ‘comply or explain’ Provisions and supporting guidance.
It is the responsibility of boards to use this flexibility wisely and of investors and their advisors
to assess differing company approaches thoughtfully

2018 Code of Corporate Governance:

- The Code is applicable to all companies with a premium listing, whether incorporated in the
UK or elsewhere.

- The new Code applied to accounting periods beginning on or after 1 January 2019.
 - For parent companies with a premium listing, the board should ensure that there is adequate
co-operation within the group to enable it to discharge its governance responsibilities under
the Code effectively.

- This includes the communication of the parent company’s purpose, values and strategy.

BOARD LEADERSHIP AND COMPANY PURPOSE

A. A successful company is led by an effective and entrepreneurial board, whose role is to promote
the long-term sustainable success of the company, generating value for shareholders and
contributing to wider society.

B. The board should establish the company’s purpose, values and strategy, and satisfy itself that
these and its culture are aligned. All directors must act with integrity, lead by example and
promote the desired culture.

C. The board should ensure that the necessary resources are in place for the company to meet its
objectives and measure performance against them. The board should also establish a
framework of prudent and effective controls, which enable risk to be assessed and managed.

D. In order for the company to meet its responsibilities to shareholders and stakeholders, the board
should ensure effective engagement with, and encourage participation from, these parties.

E. The board should ensure that workforce policies and practices are consistent with the
company’s values and support its long-term sustainable success. The workforce should be able
to raise any matters of concern.

DIVISION OF RESPONSIBILITIES

F. The chair leads the board and is responsible for its overall effectiveness in directing the company.
They should demonstrate objective judgement throughout their tenure and promote a culture of
openness and debate. In addition, the chair facilitates constructive board relations and the effective
contribution of all non-executive directors, and ensures that directors receive accurate, timely and
clear information.

G. The board should include an appropriate combination of executive and non-executive (and, in
particular, independent non-executive) directors, such that no one individual or small group of
individuals dominates the board’s decision-making. There should be a clear division of responsibilities
between the leadership of the board and the executive leadership of the company’s business.

H. Non-executive directors should have sufficient time to meet their board responsibilities. They
should provide constructive challenge, strategic guidance, offer specialist advice and hold management
to account.

I. The board, supported by the company secretary, should ensure that it has the policies, processes,
information, time and resources it needs in order to function effectively and efficiently.

COMPOSITION, SUCCESSION AND EVALUATION

J. Appointments to the board should be subject to a formal, rigorous and transparent procedure, and
an effective succession plan should be maintained for board and senior management.
 - Both appointments and succession plans should be based on merit and objective criteria and,
within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive
and personal strengths.

K. The board and its committees should have a combination of skills, experience and knowledge.
Consideration should be given to the length of service of the board as a whole and membership regularly
refreshed.

L. Annual evaluation of the board should consider its composition, diversity and how effectively
members work together to achieve objectives. Individual evaluation should demonstrate whether each
director continues to contribute effectively

AUDIT, RISK AND INTERNAL CONTROL

M. The board should establish formal and transparent policies and procedures to ensure the
independence and effectiveness of internal and external audit functions and satisfy itself on the
integrity of financial and narrative statements.

N. The board should present a fair, balanced and understandable assessment of the company’s
position and prospects.

O. The board should establish procedures to manage risk, oversee the internal control framework, and
determine the nature and extent of the principal risks the company is willing to take in order to
achieve its long-term strategic objectives.

REMUNERATION

P. Remuneration policies and practices should be designed to support strategy and promote long-term
sustainable success. Executive remuneration should be aligned to company purpose and values, and be
clearly linked to the successful delivery of the company’s long-term strategy.

Q. A formal and transparent procedure for developing policy on executive remuneration and
determining director and senior management remuneration should be established. No director should
be involved in deciding their own remuneration outcome.

R. Directors should exercise independent judgement and discretion when authorising remuneration
outcomes, taking account of company and individual performance, and wider circumstances
Unit 5
The roles and responsibilities of directors and officers under the Companies Act,
2013 are detailed, focusing on accountability, fiduciary duties, and specific
standards for governance. Here’s a breakdown based on key provisions:

Section 2(60) – Officer Who is in Default

An “officer who is in default” is responsible for penalties or punishments under the

Act and includes:

1. Whole-time Director: A full-time director overseeing specific functions.

2. Key Managerial Personnel (KMP): Includes senior executives responsible
for managing the company.
3. Directors in Absence of KMP: Directors designated by the board or all
directors if none are specified.
4. Persons with Board-Assigned Responsibilities: Those handling records,
accounts, or filings.
5. Advisors Influencing Board Actions: Anyone influencing board actions,
excluding professional advisors.
6. Directors Aware of Contraventions: Directors aware of breaches without
objection or with consent.
7. Agents in Share Issues or Transfers: Share transfer agents, registrars, and
bankers.

Section 166 – Duties of Directors

Directors must:

• Act Within Powers: Follow the company’s Articles of Association.

• Promote the Company’s Success: Act in good faith for the benefit of
members and the broader interests of employees, shareholders, and the
environment.
• Exercise Care and Diligence: Use reasonable care, skill, and independent
judgment.
 • Avoid Conflicts of Interest: Avoid direct or indirect conflicts of interest.
• Prevent Undue Gains: Directors must not exploit their position for personal
gain.
• Not Assign Office: Directors cannot transfer their role to others.
• Penalties: Breaches result in fines between Rs 1 lakh to Rs 5 lakh.

Section 203 – Appointment of Key Managerial Personnel

Companies must appoint:

1. Key Positions: A managing director or CEO, company secretary, and CFO.

2. Appointment Requirements: Terms, conditions, and remuneration must be
board-approved.
3. One Company Rule: A KMP can hold office in only one company at a time,
with some exceptions.
4. Penalty for Non-Compliance: Companies face a Rs 5 lakh penalty, with
additional fines for continued violations.

Fiduciary Duties of Directors

Directors are bound by fiduciary duties, including:

• Duty to Act Within Powers: Only exercise powers as per the company’s
articles.
• Duty to Promote Success: Make decisions benefiting members while
considering long-term consequences, employee interests, reputation, and
environmental impact.
• Duty to Exercise Independent Judgment: Avoid bias and consider the
interests of all members.
• Duty of Care, Skill, and Diligence: Apply reasonable care and any relevant
expertise.
• Duty to Avoid Conflicts of Interest: Avoid situations where personal
interests conflict with the company’s.
 • Duty to Disclose Interests: Declare any conflicts of interest in transactions.
• Duty of Loyalty: Place the company’s interests above personal interests,
avoiding gains from board service.
• Duty of Confidentiality: Maintain confidentiality on sensitive information.
• Duty of Prudence: Exercise caution in decision-making, especially in
financial matters.

Role of Non-Executive Directors (NEDs)

NEDs contribute by providing an unbiased perspective on strategic matters and

ensuring board discussions remain balanced. Their duties vary by company
maturity:

1. In New Businesses: Act as mentors, offering leadership and guidance.

2. In Established Companies: Attend board meetings, share insights, and help
ensure decisions are objective.
3. Ensuring Objectivity: Especially in group companies, NEDs provide an
impartial view on financial results and other strategic issues.

NEDs also help improve the quality of deliberations in board meetings by offering
insights aligned with the group’s risk appetite and long-term goals, ensuring the
board’s decisions reflect a fair view of the company’s state.

These roles and responsibilities underline a framework for directors to follow,

fostering transparency, accountability, and the company’s sustainable success.

Here’s a breakdown of the roles and liabilities of Non-Executive Directors (NEDs)

and the functions of the Stakeholders Relationship Committee (SRC) as per the
Companies Act 2013:

1. Role of Non-Executive Directors (NEDs)

Vital Role on Committees

 • Nomination and Remuneration Committee (NRC):
• NEDs ensure the NRC adheres to legal requirements, especially in
appointing/reappointing key personnel (like CEO, CFO).
• The NRC’s recommendations gain significance only with the support of
majority shareholders in alignment with the law.
• Audit Committee:
• NEDs provide insights on Related Party Transactions (RPTs), inter-corporate
investments, and the broader business rationale for transactions, adding value
to the committee’s decisions.

Bridge Between Key Stakeholders

• NEDs maintain communication among executive directors, independent

directors, and controlling shareholders, preventing communication gaps and
aligning interests for strategic issues.

Liabilities of NEDs

• Tax Liability: Directors may be held jointly liable if a company defaults on

tax payments due to negligence.
• Civil and Criminal Liability:
• NEDs may face civil liability if untrue statements are made in public company
documents, such as a prospectus.
• Criminal liability may apply under specific laws (e.g., for fraud under the
Indian Penal Code or cheque dishonor under the Negotiable Instruments Act).
• Exemptions from Liability:
• NEDs are generally not liable for company debts unless fraudulent actions are
involved.
• Liability for breaches of contract does not extend personally to directors,
provided they acted within their official capacity.

2. Stakeholders Relationship Committee (SRC)

Composition and Role

• Companies with over 1,000 shareholders must establish an SRC chaired by a

non-executive director.
• The SRC addresses shareholder grievances (e.g., share transfers, non-receipt
of dividends) and ensures responsive communication.

Key Functions

• Grievance Resolution: Handles complaints about transfers, dividends, and

shareholder communications.
• Oversight of Voting Rights: Reviews measures to facilitate shareholder
voting.
• Service Standards Compliance: Ensures Registrar & Share Transfer Agent
services meet established standards.
• Unclaimed Dividend Reduction: Initiates measures to reduce unclaimed
dividends, ensuring timely delivery of shareholder documents.

Penalties for Non-Compliance

• Fines may apply to companies failing to establish an SRC, and officers in

default may face penalties or imprisonment.
• While minor grievances may be exempt from liability, deliberate non-
resolution is punishable.

Website Disclosure

• The SRC must display policy details on the company’s website, including
updates within two working days of any changes, in compliance with SEBI (LODR)
regulations.

In summary, NEDs play a crucial role in governance, acting as a bridge between

management and stakeholders, ensuring lawful appointments, and enhancing
decision-making within committees like the NRC and Audit Committee. The SRC,
 mandated under the Companies Act, further ensures effective handling of
shareholder concerns and adherence to best practices in communication and
service.

Nomination and Remuneration Committee (NRC) under the

Companies Act, 2013

Requirements for Constituting the NRC

As per Section 178 of the Companies Act, 2013, and Rule 6 of the Companies
(Meetings of the Board and its Powers) Rules, 2014, the following companies are
required to form a Nomination and Remuneration Committee (NRC):

1. All public companies with a paid-up capital of ₹10 crore or more.

2. Public companies with a turnover of ₹100 crore or more.
3. Public companies with outstanding loans, borrowings, debentures, or
deposits exceeding ₹50 crore.

The paid-up capital, turnover, or outstanding borrowings, as per the last audited
financial statements, will be considered for the above criteria.

Composition of the NRC

• The committee must consist of 3 or more non-executive directors.

• At least 50% of the committee should be independent directors. For listed
companies, two-thirds of the NRC must be independent directors as per the SEBI
(LODR) Regulations, 2015.
• The Chairperson of the company may be a member, but cannot chair the
NRC.
• In listed companies, the Chairperson of the NRC must be an independent
director.
• The Chairperson or a designated member must attend the company’s
general meetings to answer queries.
Functions of the NRC

The NRC is responsible for:

1. Identifying qualified individuals for board and senior management

positions and recommending their appointment and removal.
2. Formulating criteria for determining the qualifications, positive
attributes, and independence of directors and recommending a remuneration
policy for directors, key managerial personnel (KMP), and other employees.
3. The remuneration policy should ensure that:
• Remuneration is reasonable and sufficient to attract, retain, and motivate
qualified directors.
• There is a clear relationship between remuneration and performance
with appropriate performance benchmarks.
• A balance between fixed and incentive-based pay that aligns with short-
and long-term performance goals.
4. Evaluating the performance of every director and the Board itself,
including independent directors.
5. Developing a policy on board diversity.

Key Roles of the NRC

• Formulate criteria for evaluating the qualifications, performance, and

independence of directors.
• Identify suitable candidates for appointment as directors and recommend
appointments/removals.
• Ensure effective evaluation of the performance of the Board, its committees,
and individual directors.
• Review and implement the remuneration policy within the organization.
• Devise a policy on board diversity.
• Evaluate the extension or continuation of independent directors’ terms
based on performance evaluations.
• Recommend remuneration for senior management to the Board.
 • Consider using external agencies to identify suitable candidates, and ensure
candidates’ time commitments are appropriate.

Dissemination and Transparency

• The NRC’s policies should be published on the company’s website, with

salient features, changes, and web address disclosed in the Board’s report.
• The company must update its website within 2 working days from any
changes in the NRC policy.
• The Annual Report should include a disclosure of the remuneration policy
and evaluation criteria.

Legal Implications - Observations from SMS Pharmaceuticals v/s.

Neeta Bhalla

The case highlighted criminal liability under Section 138 of the Negotiable
Instruments Act, 1881, for dishonoring a cheque issued towards the discharge of a
debt. A director or individual who issues such a cheque and it is dishonored can face
criminal penalties, including imprisonment, fine, or both, reinforcing the
importance of financial compliance in corporate governance.

Section 141 of the Negotiable Instruments Act, 1881 - Vicarious

Liability for Dishonour of Cheques

Section 141 of the Negotiable Instruments Act, 1881 extends the criminal liability
for dishonour of cheques (under Section 138) to officers of a company. This
vicarious liability is based on the person’s role and responsibility for the conduct
of the business at the time the offence was committed, rather than simply holding a
designation or office within the company.

Key Aspects of Section 141:

1. Vicarious Liability: Criminal liability for dishonour of cheque is extended

from the company (the principal accused) to the persons in charge of and
responsible for the conduct of the company’s business.
 2. Responsibility for Offence: A person is deemed to be guilty under Section
138 unless they can prove that the offence occurred without their knowledge
or despite exercising due diligence to prevent it.

Questions from the Case:

In the case related to Section 141, the following legal questions were raised:

1. Sufficiency of Allegations:
• Is it sufficient for the complaint to fulfill the substance of Section 141
requirements without specifically stating that the accused was
responsible for the conduct of business?
• Answer: Yes. The substance of the allegations must meet the requirements of
Section 141, even without explicitly stating that the person was in charge or
responsible for the company’s conduct.
2. Liability of Directors:
• Is a director of a company deemed to be responsible for the company’s
business and therefore liable unless proven otherwise?
• Answer: Yes. Directors are presumed to be responsible for the company’s
business operations and can be held liable under Section 141 unless they prove
they were not involved.
3. Liability of Specific Individuals:
• Can a managing director, joint managing director, or the signatory of the
cheque be held responsible in the absence of specific averments?
• Answer: Yes. Even without specific averments, individuals like the managing
director or joint managing director, who are responsible for the company’s
operations, can be held liable.

Vicarious Liability of Company Officers

• Section 141 establishes that criminal liability due to dishonour of a cheque

primarily lies with the drawer company, but extends to officers who were in
charge of and responsible for its operations at the time of the offence.
 • While vicarious liability is generally avoided in criminal law, Section 141 is a
specific provision that holds company officers accountable for offences committed
by the company.

Strict Compliance Required

• The conditions under Section 141 must be strictly adhered to before vicarious
liability is imposed on company officers. The officers must have a clear role or
involvement in the act leading to the dishonoured cheque.
• However, this does not apply to persons with no involvement or
responsibility in the act that led to the dishonour.

Liability Based on Role, Not Designation

• The Supreme Court has clarified that liability under Section 141 depends on
the role a person plays in the company’s operations, not merely on their
designation. A person who was in charge of and responsible for the business at
the time of the offence can be held liable, regardless of their formal office within
the company.

Union Carbide Corporation v. Union of India (1988) – The Bhopal

Gas Leak Case

The Bhopal gas leak tragedy (1984) is another landmark case in Indian law,
addressing liability in cases involving strict and absolute liability.

Facts of the Case:

• On December 2, 1984, a methyl isocyanate (MIC) gas leak from the Union
Carbide India Limited (UCIL) plant in Bhopal led to the deaths of thousands and
caused irreparable damage to many others.
• The Union Carbide Corporation (UCC), a U.S. company, was the majority
shareholder of UCIL.
• The leak occurred in an area not zoned for hazardous industries, with a plant
that was only approved to produce small quantities of pesticides.
Court Ruling and Principles:

• The Supreme Court applied the principle of strict liability established in

Rylands v. Fletcher and expanded it to absolute liability in industrial accidents
causing large-scale harm.
• The case led to the Bhopal Gas Leak Disaster (Processing of Claims) Act,
1985, which allowed the Indian Government to represent victims and pursue
claims for compensation.
• The Supreme Court eventually awarded interim compensation and
increased the amount to USD 470 million, significantly lower than the original
claims.

Key Legal Precedents:

• The Union Carbide case reiterated the need for strict liability and laid
down the principle that industries involved in hazardous activities must be held
absolutely liable for damages resulting from such activities, even without proof
of negligence.
• The absolute liability doctrine holds companies liable for harm caused by
their operations without the need to prove fault, especially in cases where the
activity is inherently dangerous.

Impact on Indian Law:

• This case led to the Environment Protection Act, 1986 and Public Liability
Insurance Act, 1991, aiming to provide better protection to citizens from
environmental harm.
• It also expanded the Right to Life (Article 21) to include the right to live in a
pollution-free environment.

In summary, Section 141 of the Negotiable Instruments Act extends criminal liability
for dishonour of cheques to officers responsible for the company’s conduct, based
on their involvement, not merely their office. The Union Carbide case also
highlighted the importance of strict and absolute liability, especially in cases
 involving industrial accidents causing massive harm to public health and the
environment.

Issues in the Case

1. Validity of the Settlement Amount: Whether the compensation amount

awarded in the Bhopal gas tragedy case was justified and adequate for the
victims.
2. Dropping of Criminal Proceedings: Whether the decision to drop criminal
proceedings against Union Carbide was justified, considering the magnitude of
the tragedy.

Judgment

The Supreme Court invoked the doctrine of absolute liability, establishing that
the company’s liability could be fixed even in the absence of negligence. This
principle expands beyond the traditional framework of strict liability, holding
companies responsible for harm caused by their activities, irrespective of fault.

Majority Opinion

• Justice Venkatachaliah and Justices K.N. Singh and N.D. Ojha formed the
majority, while CJ Mishra concurred with them. Justice Ahmadi delivered a
minority opinion.
• The majority opinion held that:
1. Criminal Proceedings: The dropping of criminal proceedings against
Union Carbide was unjustified. The Supreme Court quashed the earlier order
that had dropped the proceedings, directing that criminal actions must be
initiated without delay.
2. Compensation: The compensation awarded was adequate,
reasonable, and fair in light of the situation. In case any further financial
need arose for rehabilitation, the Union and State governments were to
bear the additional costs.

Union Carbide’s Responsibility

 • Union Carbide Corporation was directed to pay 470 million dollars to the
Union of India by March 31, 1989, in settlement of all claims arising from the
disaster. The Supreme Court emphasized that this sum was adequate to address
the needs of the victims and their rehabilitation.

Ratio Decidendi (Legal Reasoning)

• The Supreme Court’s reasoning was based on several factors:

1. Compensation Calculation: The Court evaluated the compensation by
considering elements such as the number of persons treated, fatalities, and
the nature of injuries. It used the High Court’s assessment of claims in
amended pleadings, which included an estimate of 3000 fatalities and
compensation ranging from Rs. 1 lakh to Rs. 3 lakh per person. This led to an
estimated total compensation of around 70 crore rupees.
2. Need for National Policy: The Court stressed the importance of
creating a national policy to protect citizens from the dangers posed by ultra-
hazardous industries. It called for the involvement of experts from various
fields (jurists, economists, environmentalists, sociologists, and futurologists)
to formulate criteria that could guide future legal decisions and ensure safer
practices for the public.
3. Evolving Legal Standards: The judgment highlighted the need for a
revised legal framework for handling incidents involving ultra-hazardous
industries. This would protect national interests while holding corporations
accountable for the long-term effects of their operations.

Key Takeaways

• The doctrine of absolute liability was firmly established by the Supreme

Court, ensuring that companies engaging in ultra-hazardous activities would be
held accountable regardless of negligence.
• The Court upheld the compensation amount as fair but emphasized the
need for a comprehensive policy to handle such cases and ensure future
accountability.
• Criminal liability was not to be dismissed, and the proceedings against
Union Carbide were revived, sending a strong message about corporate
responsibility in cases of catastrophic harm to public health and the environment.
Unit 6
INDEPENDENT DIRECTORS

- The concept of Independent Directors emerged when the Cadbury Committee in 1992 was set
up following the corporate scandals

- The focus was on appointment of independent directors as a part of the new practices for better
governance.

- IDs function as an oversight body in monitoring the performance and raise red flags whenever
suspicion occurs.

- are expected to be more aware and question the company on relevant issues in their position
as trustees of stakeholders.

- Are critical for ensuring good corporate governance and it is necessary that the functioning of
the institution is critically analysed and proper safeguards are made to ensure efficacy.

- An independent director means a director other than a managing director or a whole-time

director or a nominee director who does not have any material or pecuniary relationship with the
company/ directors.

- Basically an independent director is a non-executive director.

DEFINITION OF INDEPENDENT DIRECTOR (Section 149(6) )

- a director other than a managing director or a whole time director or a nominee director,-

(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and
experience;

(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;

- (ii) who is not related to promoters or directors in the company, its holding, subsidiary or
associate company;

- (c) who has or had no pecuniary relationship other than remuneration as such director or
having transaction not exceeding 10 % of his total income or such amount as may be
prescribed with the company, its holding, subsidiary or associate company, or their promoters,
or directors, during the 2 immediately preceding financial years or during the current financial
year.

(d) none of whose relatives have or had pecuniary relationship

(i) is holding any security of or interest in the company, its holding, subsidiary or associate
company during the two immediately preceding financial years or during the current financial year:

• Provided that the relative may hold security or interest in the company of face value not
exceeding fifty lakh rupees or 2 % of the paid-up capital of the company, its holding, subsidiary
or associate company or such higher sum as may be prescribed;
(ii) is indebted to the company, its holding, subsidiary or associate company or their promoters, or
directors, in excess of such amount as may be prescribed during the 2 immediately preceding financial
years or during the current financial year ;

(iii) has given a guarantee or provided any security in connection with the indebtedness of any third
person to the company, its holding, subsidiary or associate company or their promoters, or directors of
such holding company, for such amount as may be prescribed during the two immediately preceding
financial years or during the current financial year; or

(iv) has any other 2 % or more of its gross turnover or total income singly or in combination with the
transactions referred to in sub-clause (i), (ii) or (iii);

DEFINITION OF INDEPENDENT DIRECTOR (Section 149(6) ) contd…….

(e) who, neither himself nor any of his relatives—

(i) holds or has held the position of a KMP or is or has been an employee of the company or its
holding, subsidiary or associate company in any of the 3 financial years immediately preceding the
financial year in which he is proposed to be appointed;

(ii) is or has been an employee or proprietor or a partner, in any of the 3 financial years immediately
preceding the financial year in which he is proposed to be appointed, of—

(A) a firm of auditors or company secretaries in practice or cost auditors of the company or its holding,
subsidiary or associate company; or

(B) any legal or a consulting firm that has or had any transaction with the company, its holding,
subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;

(iii) holds together with his relatives 2 % or more of the total voting power of the company; or

(iv) is a CEO or director, by whatever name called, of any nonprofit organisation that receives 25% or
more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or
associate company or that holds 2% or more of the total voting power of the company; or

(f) who possesses such other qualifications as may be prescribed.

NUMBER OF INDEPENDENT DIRECTORS

- Section 149(4) provides that every listed public company shall have at least one-third of the
total number of directors as independent directors and the Central Government may prescribe
the minimum number of independent directors in case of any class or classes of public
companies

- Rule 4 of Companies (Appointment and Qualification of Directors) rules 2014, provides that the
following class or classes of companies shall have at least two directors as independent
directors –

(i) the Public Companies having paid up share capital of ten crore rupees or more; or

(ii) the Public Companies having turnover of one hundred crore rupees or more; or
(iii) the Public Companies which have, in aggregate, outstanding loans, debentures and deposits,
exceeding fifty crore rupees.

Manner of appointment of ID:

(1) shall be independent of the company’s management - while selecting independent directors
the Board shall ensure that there is appropriate balance of skills, experience and knowledge in
the Board so as to enable the Board to discharge its functions and duties effectively.

(2) shall be approved at the meeting of the shareholders.

(3) The explanatory statement attached to the notice of the meeting for approving the
appointment of independent director shall include a statement that in the opinion of the
Board, the independent director proposed to be appointed fulfils the conditions specified in the
Act and the rules made thereunder and that the proposed director is independent of the
management.

(4) The appointment of independent directors shall be formalised through a letter of

appointment, which shall set out :

(a) the term of appointment;

(b) the expectation of the Board from the appointed director; the Board-level committee(s) in
which the director is expected to serve and its tasks;

(c) the fiduciary duties that come with such an appointment along with accompanying liabilities;

(d) provision for Directors and Officers (D and O) insurance, if any;

(e) the Code of Business Ethics that the company expects its directors and employees to follow;

(f) the list of actions that a director should not do while functioning as such in the company; and

(g) the remuneration, mentioning periodic fees, reimbursement of expenses for participation in
the Boards and other meetings and profit related commission, if any.

(5) The terms and conditions of appointment of independent directors shall be open for inspection at
the registered office of the company by any member during normal business hours.

(6) The terms and conditions of appointment of independent directors shall also be posted on the
company’s website.

The appointment, re-appointment or removal of an independent director of a listed entity, shall be

subject to the approval of shareholders by way of a special resolution

DECLARATION BY AN INDEPENDENT DIRECTOR- Section 149 (7)

- every independent director shall give a declaration that he meets the criteria of independence
when:

(a) he attends the first meeting of the Board as a director;

(b) thereafter at the first meeting of the Board in every financial year and
(c) whenever there is any change in the circumstances which may affect his status as an independent
director.

- Additionally for listed entities, SEBI along with the above, an additional mention shall be made in
the declaration stating that he is not aware of any circumstance or situation, which exists or
may be reasonably anticipated, that could impair or impact his ability to discharge his duties
with an objective independent judgment and without any external influence.

CODE FOR INDEPENDENT DIRECTORS –

- Section 149 (8) of the Act prescribes that the company and independent directors shall abide
by the provisions specified in Schedule IV regarding code for independent directors.

- It is a guide to professional conduct for independent directors.

- Adherence to these standards by independent directors and fulfilment of their responsibilities in

a professional and faithful manner will promote confidence of the investment community,
particularly minority shareholders, regulators and companies in the institution of independent
directors.

Guidelines of professional conduct of an Independent Director:

An independent director shall:

(1) uphold ethical standards of integrity and probity;

(2) act objectively and constructively while exercising his duties;

(3) exercise his responsibilities in a bona fide manner in the interest of the company;

(4) devote sufficient time and attention to his professional obligations for informed and balanced
decision making;

(5) not allow any extraneous considerations that will vitiate his exercise of objective independent
judgment in the paramount interest of the company as a whole, while concurring in or
dissenting from the collective judgment of the Board in its decision making;

(6) not abuse his position to the detriment of the company or its shareholders or for the purpose of
gaining direct or indirect personal advantage or advantage for any associated person;

(7) refrain from any action that would lead to loss of his independence;

(8) where circumstances arise which make an independent director lose his independence, the
independent director must immediately inform the Board accordingly;

(9) assist the company in implementing the best corporate governance practices.

Role and functions of independent directors:

(1) help in bringing an independent judgment to bear on the Board’s deliberations especially on
issues of strategy, performance, risk management, resources, key appointments and standards
of conduct;
 (2) bring an objective view in the evaluation of the performance of board and management;

(3) scrutinise the performance of management in meeting agreed goals and objectives and monitor
the reporting of performance;

(4) satisfy themselves on the integrity of financial information and that financial controls and the
systems of risk management are robust and defensible;

(5) safeguard the interests of all stakeholders, particularly the minority shareholders;

(6) balance the conflicting interest of the stakeholders;

(7) determine appropriate levels of remuneration of executive directors, key managerial personnel
and senior management and have a prime role in appointing and where necessary recommend
removal of executive directors, key managerial personnel and senior management;

(8) moderate and arbitrate in the interest of the company as a whole, in situations of conflict
between management and shareholder’s interest.

Duties of independent directors:

(1) undertake appropriate induction and regularly update and refresh their skills, knowledge and
familiarity with the company;

(2) seek appropriate clarification or amplification of information and, where necessary, take and
follow appropriate professional advice and opinion of outside experts at the expense of the
company;

(3) strive to attend all meetings of the Board of Directors and of the Board committees of which he
is a member;

(4) participate constructively and actively in the committees of the Board in which they are
chairpersons or members;

(5) strive to attend the general meetings of the company;

(6) where they have concerns about the running of the company or a proposed action, ensure that
these are addressed by the Board and, to the extent that they are not resolved, insist that their
concerns are recorded in the minutes of the Board meeting;

(7) keep themselves well informed about the company and the external environment in which it
operates;

(8) not to unfairly obstruct the functioning of an otherwise proper Board or committee of the
Board;

(9) pay sufficient attention and ensure that adequate deliberations are held before approving
related party transactions and assure themselves that the same are in the interest of the
company;
 (10) ascertain and ensure that the company has an adequate and functional vigil mechanism and to
ensure that the interests of a person who uses such mechanism are not prejudicially affected on
account of such use;

(11) report concerns about unethical behaviour, actual or suspected fraud or violation of the
company’s code of conduct or ethics policy;

(12) acting within his authority, assist in protecting the legitimate interests of the company,
shareholders and its employees;

(13) not disclose confidential information, including commercial secrets, technologies, advertising
and sales promotion plans, unpublished price sensitive information, unless such disclosure is
expressly approved by the Board or required by law.

Resignation or removal:

- An independent director who resigns or is removed from the Board of the company shall be
replaced by a new independent director within a period of not more than 180 days from the
date of such resignation or removal, as the case may be.

Evaluation mechanism:

(1) The performance evaluation of independent directors shall be done by the entire Board of
Directors, excluding the director being evaluated.

(2) On the basis of the report of performance evaluation, it shall be determined whether to extend
or continue the term of appointment of the independent director.

Separate meetings:

(1) The independent directors of the company shall hold at least one meeting in a year, without
the attendance of non-independent directors and members of management;

(2) All the independent directors of the company shall strive to be present at such meeting;

(3) The meeting shall:

(a) review the performance of non-independent directors and the Board as a whole;

(b) review the performance of the Chairperson of the company, taking into account the views of
executive directors and non-executive directors;

(c) assess the quality, quantity and timeliness of flow of information between the company
management and the Board that is necessary for the Board to effectively and reasonably
perform their duties.

REMUNERATION OF INDEPENDENT DIRECTOR (Section 149(9) )

- an independent director shall not be entitled to any stock option and may receive remuneration
by way of fee provided under section 197(5),

- reimbursement of expenses for participation in the Board and other meetings and
 - profit related commission as may be approved by the members.

TENURE OF INDEPENDENT DIRECTOR

- Section 149(10) an independent director shall hold office for a term up to five consecutive years
on the Board of a company, but shall be eligible for reappointment on passing of a special
resolution by the company and disclosure of such appointment in the Board's report.

- Section 149(11) states that without contravening the section 149(10), no independent director
shall hold office for more than two consecutive terms, but such independent director shall be
eligible for appointment after the expiration of three years of ceasing to become an
independent director.

- Proviso to Section 149(11) that an independent director shall not, during the said period of
three years, be appointed in or be associated with the company in any other capacity, either
directly or indirectly.

LIABILITY OF INDEPENDENT DIRECTOR - Section 149(12)

- provides that, notwithstanding anything contained in this Act,—

(i) an independent director;

(ii) a non-executive director not being promoter or key managerial personnel, shall be held liable,
only in respect of such acts of omission or commission by a company which had occurred with
his knowledge, attributable through Board processes, and with his consent or connivance or
where he had not acted diligently.

MANNER OF SELECTION OF AN INDEPENDENT DIRECTOR

- Section 150 (1) - independent directors may be selected from a data bank of eligible and
willing persons maintained by the agency (Any body, institute or association as may be
authorised by Central Government).

- Such agency shall put data bank of independent directors on the website of MCA or any other
notified website.

- Company must exercise due diligence before selecting a person from the data bank referred to
above, as an independent director.

- the appointment of independent directors has to be approved by members in a General meeting

and the explanatory statement annexed to the notice must indicate justification for such
appointment.

- Any person who desires to get his name included in the data bank of independent directors shall
make an application to the agency

- Application for inclusion of name in the databank of Independent Directors which includes the
personal, educational, professional, work experience, other Board details of the applicant
{Rule 6(4)].
 - The agency may charge a reasonable fee from the applicant for inclusion of his name in the
data bank of independent directors {Rule 6 (5)]

- An existing or applicant of such data bank of independent directors shall intimate any changes in
his particulars within fifteen days of such change to the agency {Rule 6 (6)}.

- Rule 6 (7) prescribed that the databank posted on the website shall:

a. be accessible at the specified website;

b. be substantially identical to the physical version of the data bank;

c. be searchable on the parameters specified in rule 6 (2);

d. be presented in a format or formats convenient for both printing and viewing online; and

e. contain a link to obtain the software required to view print the particulars free of charge.

Imp points to note in relation to Independent Directors:

- Every ID who intends to get appointed as an independent director in a company shall before
such appointment, apply online for inclusion of his name in the data bank for a period of one
year or five years or for his life-time (https://www.independentdirectorsdatabank.in/)

- Every individual whose name is so included in the data bank shall pass an online proficiency
self-assessment test conducted by the institute (IICA) within a period of one year from the date
of inclusion of his name in the data bank, failing which, his name shall stand removed from the
databank

• an individual who has obtained a score of not less than fifty percent (50%) in aggregate in the
online proficiency self-assessment test shall be deemed to have passed such test;

• there shall be no limit on the number of attempts an individual may take for passing the online
proficiency self-assessment test.

Other provisions of the amendment:

- Appointment/Re-appointment and Removal of IDs shall be through a special resolution of

shareholders for all listed entities

- The process to be followed by Nomination and Remuneration Committee (NRC), while

selecting candidates for appointment as IDs, has been elaborated and made more transparent
including enhanced disclosures regarding the skills required for appointment as an ID and how
the proposed candidate fits into that skillset.

- Shareholder approval for appointment of all directors including IDs shall be taken at the next
general meeting, or within three months of the appointment on the Board, whichever is
earlier.

- A cooling off period of three years has been introduced for Key Managerial Personnel (and their
relatives) or employees of the promoter group companies, for appointment as an ID.
 - Relatives of employees of the company, its holding, subsidiary or associate company have
been permitted to become IDs, without the requirement of a cooling-off period, in line with
Companies Act, 2013.

- The entire resignation letter of an ID shall be disclosed along with a list of her/his present
directorships and membership in board committees.

- A cooling-off period of one year has been introduced for an ID transitioning to a whole-time
director in the same company/ holding/ subsidiary/ associate company or any company
belonging to the promoter group

- At least 2/3rdof the members of the audit committee shall be independent directors and

- all related party transactions shall be approved by only Independent Directors on the Audit
Committee.

Tata Sons v. Cyrus Mistry

- Shapoorji Pallonji Group Scion Cyrus Mistry had succeeded Ratan Tata as the Chief and
Chairperson of Tata Sons in 2012.

- He was declared as the Future of Tata Sons.

- Four Years later he was unceremoniously shown the door by his mentor, none other than Mr
Ratan Tata himself.

- the Mistry family does have a holding of 18.4% stakes in Tata Groups

- The Late Mr Cyrus Pallonji Mistry was the scion of Shapoorji Pallonji Group and he was an Irish
businessman of Indian origin. He was the Sixth Chairman of Tata Group and remained seated on
that Chair from 2012 to 2016, after which he was voted out by the Board of Tata Group and Mr.
Ratan Tata returned as its Interim Chairman, and a few months later Mr. Natrajan
Chandrasekaran from TCS was chosen as the new Chairman who was re-appointed for a term of
5 years starting last week of February 2022

- When Mr. Ratan Tata stepped down from the position of Chairperson of Tata group, the selection
panel of Tata Group selected Mr. Cyrus Mistry as his successor. The candidature of Mr. Mistry
was also strongly supported by Mr. Ratan Tata at that point of time

- differences arose between him and other Directors over his style of functioning and gradually an
atmosphere of lack of confidence and trust was built up.

- Differences arose also between Mr. Mistry and Mr. Ratan Tata also over his style of functioning
which was considered as too autocratic and not in consonance with democratic management
style being practiced by Tata Group and Bombay House.

- a decision of him taken in June 2016 when he finalized Tata Power’s acquisition of Welspun’s
Solar farms for Rs 1.4 Billion without even consulting and taking approval of Mr. Ratan Tata and
other key shareholders.
 - It was not the way the business had been run at the Bombay House and he questioned many
projects and their profit effects specifically Mr.Tata’s very own ‘Nano’ Project, a dream he
envisioned and brought to reality for common middle class Indians.

- on October 24, 2016, Mistry was removed from the Chairmanship of Tata Sons after a majority
of the Board of Directors voted for his removal due to loss of confidence.

- Further, after his removal, concerted efforts were also made to remove him from all the group
companies including Shapoorji Pallonji Group.

- Mr Ratan Tata returned as Interim Chairman of Tata Group.

- Finally on 12th January 2017, Sri N Chandrashekaran, then Chief Executive Officer and Managing
Director of TCS was appointed as the Chairman of Tata Sons.

- Mistry was also removed from the Board of Tata Sons as Director on 6th February 2017.

- Mr Cyrus Mistry filed an application under Section 241 and 242 of the Companies Act before
the National Companies Law Tribunal

- Further with NCLAT

- Lastly with the Hon’ble SC of India.

The Supreme Court judgment and its impact on corporate governance

- The Order of the Supreme Court was viewed by a majority of Legal experts as a resounding
victory for Tata Group and in particular Mr Ratan Tata who was amongst the first to welcome the
order.

- It has, however, given rise also to many unanswered questions in the field of corporate
governance.

- Many experts also felt that the minority shareholders were not given a fair deal by the Apex
Court.

- Further, some strong observations by the Apex Court have also created more doubts regarding
the validity of the long standing principles of Corporate Governance such as:

a. In what manner duties of Directors shall be determined?

b. Does it depend on the Company they work for?

c. What are the roles and fiduciary duties of Nominee Directors?

d. Do the Directors nominated by charitable Trusts have wider responsibilities to the public than
other Directors?

Independence of Independent Directors?

- The bitter boardroom battle at the heart of Tata Sons has put a spotlight on the vulnerability of
India’s independent company directors who stand-up to, or take on a dominant shareholder
 - Tata Sons was not only fighting former chairman Cyrus Mistry, who has complained of
mismanagement and corporate governance failures within the company,

- but was also trying to question Nusli Wadia—one of the group’s most fiercely vocal independent
directors—after he publicly backed Mistry

- Many argue that the independence of the independent directors is at stake

- Does acting independently amount/account a threat of removal

- In developed markets such as the United States and the United Kingdom, independent directors
are relatively protected as shareholdings are much more diffused.

- But in India, listed firms are dominated by a major shareholder, making it easier for the latter to
stamp out dissenting independent voices

- Nusli Wadia was an independent director on the boards of several Tata Group companies, and he
chose to support Cyrus Mistry in the feud. His role as an independent director was to provide an
objective and unbiased perspective on corporate governance matters, representing the interests
of all shareholders and ensuring that the company's actions were in compliance with relevant
laws and regulations.

- Wadia's support for Mistry and his vocal criticism of the decision to remove Mistry as Chairman
put him in direct conflict with Ratan Tata and the Tata Group. This conflict escalated into a legal
battle, with both sides filing lawsuits and making allegations against each other.

- Wadia's stance as an independent director supporting Mistry raised questions about the
independence of directors on corporate boards and the influence that major shareholders, like
the Tata family, can have on decision-making within large conglomerates. It also highlighted the
complexities and challenges involved in governance and succession planning in family-controlled
business groups.

- Ultimately, in early 2017, Wadia was removed from the boards of some Tata Group companies
due to a loss of confidence by the boards and shareholders in his ability to act independently.
The legal battles between Mistry and the Tata Group continued for several years and had
significant repercussions for corporate governance and shareholder rights in India.

Reference reading

https://www.thehindu.com/business/Institution-of-%E2%80%98independent-director%E2%80%99-
under-trial-Nusli-Wadia/article16798213.ece

https://www.tatasteel.com/media/1568/nnw-representation-to-bse-nse.pdf

Representation of removal of Mr. Nusli Wadia from Tata Steel

IL&FS Case:

- In this case the role of Independent directors under MCA’s scanner

- The role of auditors, credit rating agencies and some top officials of IL&FS too was severely
condemned

- Independent directors of various IL&FS companies are under the scanner of the corporate affairs
ministry for alleged lapses in carrying out their duties as financial problems continued to brew at
the diversified group, according to sources.

- The crisis at IL&FS, which is estimated to have a debt burden of over Rs 94,000 crore, came to
light last year after some group companies defaulted on debt repayments.

- The sources said independent directors of various group companies have under the ministry's
lens, including individuals who are on the boards of blue chip firms.

- The role of auditors, credit rating agencies and some former officials entities are already being
looked into by the ministry, which had superseded the IL&FS board in October 2018. The Serious
Fraud Investigation Office (SFIO) is probing the matter.

- The ministry is already working on ways to further strengthen the framework for independent
directors, who have an important role in ensuring good corporate governance practices at
companies.

- IL&FS group last year, following huge defaults by various entities which together had a debt
burden of over ₹90,000 crore.

- The government had to supersede its board and appoint a new one, which is now working to
clear the mess and also recover the losses caused by fraudulent acts of the previous
management. The matter is being probed by multiple agencies, including the Serious Fraud
Investigation Office (SFIO), which has also found connivance of the previous top management
with auditors and independent directors.

- Several entities of IL&FS (Infrastructure Leasing and Financial Services) group have been found to
have indulged in multiple circuitous transactions involving several illegalities, including fast
disbursals to some borrowers despite their bad track record in servicing existing loans and also
delayed recoveries.

- Investigations have also found that several entities from the IL&FS group continued to enjoy high
ratings from various rating agencies, including due to window-dressing of the books of the
companies and ever-greening of their loans.

- As per the probe, a number of borrowers, including listed firms, were not servicing their debt
obligation timely.

- While the top management at IL&FS was aware of the potential problem accounts which were
getting stressed, they continued to provide them with fresh loans to serve their principal and
interest of the defaulters, rather than classifying them as NPAs.

- This process was repeated multiple times with the earlier loan facility getting closed and a new
facility being created which was again funded, on their default, through another cycle of funding
through the same or another group company.
- Such manner of debt servicing led to ballooning up of the outstanding liabilities against a group,
which were funded from the borrowings from the market.

- Ultimately, the final loan facility was declared NPA or written off, or left still outstanding in
several cases, resulting in delayed recognition of NPAs, ballooning of debt and ultimate higher
loss to the lender and its stakeholders.

- It was also found that the top management took hospitality from the defaulter borrowers, while
some auditors and rating agency officials were also found to be taking favours, officials said.

- In its first chargesheet concerning the group's NBFC arm IL&FS Financial Services Ltd (IFIN), the
SFIO has charged its erstwhile top management members of forming a "coterie" with its auditors
and independent directors to defraud the company while running the business as their "personal
fiefdom".

- In addition to prosecution of former executive and independent directors of IFIN, among others,
and attachment of their properties, the SFIO is also seeking interim attachment of all moveable
and immovable assets of the auditors including their lockers, bank accounts and jointly-held
properties, officials said.

- The SFIO is also collecting details about all borrowings by IFIN from banks and through market
instruments, as also about the role of banks and their officials and of credit rating agencies.

- In its chargesheet filed before a special court, the SFIO has accused 30 entities/individuals of
various violations and offences, including financial fraud. Some of the accused persons are
already in judicial custody.

- Former top-management members of IFIN have been charged with committing fraud with intent
to injure the interest of the company, its shareholders and creditors, resulting in wrongful loss to
the company.

- Listing names of Deloitte Haskins and Sells LLP and BSR and Associates LLP in the chargesheet,
the SFIO said, "The statutory auditors failed to discharge their duties diligently and did not use
professional scepticism to ensure true and fair disclosure of the state of affairs of the company".

- "They, in fact, colluded with officials of the companies in order to conceal their fraudulent
activities," the SFIO said while citing documentary and digital evidence as also relevant portions
from its investigation report about statements recorded during the course of the probe.

- Infrastructure Leasing & Financial Services Limited (IL&FS) is a systemically important Core
Investment Company with the Reserve Bank of India and is engaged in the business of giving
loans and advances to its group companies (and holding an investment in such companies).

- IL&FS has a large number of group companies across various sectors such as Energy,
Transportation, Financial Services etc. IL&FS was initially promoted by the Central Bank of India,
HDFC Limited and the Unit Trust of India.

- IL&FS Group, which has approximately over Rs. 91,000 crores in debt, is facing a severe liquidity
crisis.
 - Between July 2018 and September 2018, two of the subsidiaries of IL&FS Group reported having
trouble in paying back loans and inter-corporate deposits to banks/lenders.

- The liquidity crisis in IL&FS Group – Role of Central Government

- In July 2018, the road arm of IL&FS was facing difficulty in making repayments due on its bonds.

- Further, in early September 2018, one of the subsidiaries of IL&FS Group was unable to repay a
short-term loan of Rs. 1,000 crore taken from Small Industries Development Bank of India
(SIDBI).

- Also, certain group companies defaulted in repayments of various short and long-term deposits,
inter-corporate deposits, and commercial papers.

- IL&FS failed continuously to service its debt and the imminent possibility of a contagion effect in
the financial market led the Central Government to move an application under Sections 241 and
242 of the Companies Act, 2013 before the NCLT, Mumbai Bench.

- It sought the immediate suspension of the Board of Directors of IL&FS and the appointment of
specified new directors, on the ground of massive mismanagement of public funds by the
erstwhile Board. It was also alleged that the affairs of the company were being conducted in a
manner prejudicial to the public interest.

Suspension of existing Board of Directors (NCLT order)

- By way of an order dated October 1, 2018, the NCLT invoked its powers under Sections 242, 242,
246 r/w 339 of the Companies Act and granted the interim prayer of suspending the existing
Board of Directors and reconstituting the same with the six persons proposed by the Centre.

- The NCLT further restrained the suspended members of the Board from alienating their personal
assets. Mr. Uday Kotak is the chairman of the new Board of Directors. The new Board has been
tasked with the orderly resolution of IL&FS and its group companies.

- The NCLT also directed the filing of progress reports until resolution, which is a continuous
process.

- Through subsequent orders, the NCLT allowed the appointment of three additional directors,
bringing the total number of directors to nine.

Grant of immunity to new Directors (NCLT order)

- In order to ensure the independent functioning of the said directors individually and
collectively, immunity was granted to them.

- The NCLT directed that for the past actions of the suspended directors or any of the officers of
the company, no action should be initiated against the newly appointed directors, without prior
approval of the Tribunal.

Grant of moratorium (NCLAT order)

 - Further, in order to ensure a period of calm during the resolution process, a moratorium was
sought qua IL&FS and its group companies against certain creditor actions.

- The reason for seeking this moratorium was the impending threat of adverse legal actions by
creditors and the absence of a legal framework to address the financial crisis of the IL&FS Group.

- The new Board would require the status quo to be preserved in respect of the business and
assets of the IL&FS Group in order to effectively implement the orders of the NCLT and arrive at
a fair resolution for the company. This was declined by the NCLT by its order dated October 12,
2018.

- However, upon appeal, the National Company Law Appellate Tribunal (NCLAT) granted a
moratorium on an interim basis until further orders. The matter is sub-judice.

SFIO interim report and NCLT order

- The Serious Fraud Investigation Office (SFIO) submitted an interim report dated November 30,
2018.

- On the basis of this interim report, the Central Government vide its affidavit dated December 3,
2018, sought the impleadment of more persons as respondents in the original petition.

- NCLT vide its order dated December 3, 2018., granted relief to the Central Government who filed
an application for seeking orders, qua the additional respondents, to restrain them from
mortgaging or creating charge or lien or creating third party interest or in any way alienating, the
movable or immovable properties owned by them, including jointly held properties. The same is
still in operation, and as on date, there are a total of 318 respondents in the petition before the
NCLT.

Role of ICAI

- In view of the negative impact that the IL&FS Group has had on the financial markets at large,
and there being considerable allegations in respect of the financial statements of the said
companies, the Disciplinary Directorate of the Institute of Chartered Accountants of India
(ICAI) suo motu sought to consider the performance of the statutory auditors of the said
companies.

- Pursuant to an enquiry conducted in respect of the statutory auditors of the IL&FS Group
Companies, the ICAI found that there were key lapses, shortcomings, and manipulations on the
financial statements by the statutory auditors of the said companies.

- It was noted that the condition of the said companies as a result of mismanagement reflects
upon the statutory auditors of the said companies. The ICAI has held the statutory auditors of
the said companies prima facie guilty of professional misconduct.

- Meanwhile, a spur between ICAI and National Financial Reporting Authority (NFRA) – a recently
formed regulator under Ministry of Corporate Affairs – has raised questions as to who is going to
look into the role of the auditing firms. As per sources, NFRA has initiated a probe into the
matter.
Status of Debt-Ridden Entities of IL&FS Group

- NCLAT vide order dated July 12, 2019, asked the IL&FS and MCA whether any red entity can be
categorized into “green entity” or “amber entity”. No specific statement was made in regard to
the one or more red entities.

- The Hon’ble court granted a two weeks time to IL&FS and Union to file an affidavit stating the
action they intend to take with regard to 55 loss-making red entities. IL&FS and Union will also
inform the steps required to be taken for the other Red Entities.

- NCLAT directed IL&FS and Union to state in their affidavit the proposed steps they will take to
release the amounts payable towards “Pension Fund, Provident Fund, Army Group Insurance
Fund, Gratuity Fund, Superannuation Fund, Postal Life Insurance Fund, etc, if invested in one or
other Red Entity.

- IL&FS informed that three amber listed companies- Jharkhand Road Projects Implementation
Company, West Gujarat Expressway, and Moradabad Bareilly Expressway, would be upgraded to
Green entities. The matter is listed for hearing on August 8, 2019.

Proceeding against Auditors

- Ministry of Corporate Affairs proceeded to start a prosecution against the auditors of IL&FS
based on the Serious Fraud Investigation Report ((SFIO).

- Thereby Deloitte and BSR Associates are prosecuted for their failure to detect and report the
scams that took place involving IL&FS and its 21 entities when they were the auditors of the
IL&FS.

- The NCLT vide its order dated July 18, 2019 accepted and allowed the request of MCA. The
Auditors Deloitte and BSR are currently arguing before NCLT that “the NCLT can’t pass final order
to ban auditors under Section 140(5) of IBC on prima facie evidence of fraud and an auditor,
which has already resigned can’t be double punished”.

- The arguments of the Auditors are being heard on Monday (July 22, 2019).

- NCLT also allowed the prosecution of C Sivasankaran and his group based on the SFIO report.
The report revealed that the management of IFIN has missed their position to give loans to Shiv
Group ignoring the fact that many companies failed to repay the loans given by the IFIN.

- Tribunal also allowed the MCA to implead Surinder Singh Kohli and Subhalakshmi Panse who
were the independent director of IFIN and member of Audit Committee who were aware of the
NPAs of the company and knew that loans were granted to the already defaulting borrowers.

- The auditors argued that NCT didn’t have a jurisdiction to decide the government demand for a
five-year ban against the auditors of IL&FS.

PNB scam

- On February 14th 2018, Punjab National Bank (PNB), disclosed that it had been defrauded out of
roughly 1.8 billion dollars. This news shook the nation and all eyes turned to the culprit Nirav
Modi, a rich diamond tycoon. This article details the true nature of the fraud, its repercussions
 and just how Nirav Modi and his associates pulled off one of the biggest bank scams in Indian
history.

- The PNB scam is basically a case of financial fraud that was committed by Nirav Modi and his
associates who colluded with senior Punjab National Bank employees. To better understand the
fraud and what it is all about we have to understand certain other basic concepts first.

- Society for Worldwide Interbank Financial Telecommunications (SWIFT) is a cooperative society

headquartered in Belgium. The primary role of SWIFT is to carry secure financial messages from
one bank to the other. That is, if one bank wants to send a message to another bank, SWIFT
carries the message in a safe and secure way, without altering the message. It is often
misunderstood that SWIFT transfers money, this, however, is not the case. SWIFT is not involved
in settling or clearing fund transfers, it only transfers secure messages.

- In the case of PNB, the two employees directly used SWIFT to move millions of dollars across
borders every hour— and bypassed the core banking system (CBS) which processes daily
banking transactions and posts updates.

Letter of Undertaking

- Letter of undertaking, (LOU) is basically an instrument used by importers to carry out their
business.

- For example, an Indian businessman has businesses in the US, he procures raw materials from a
seller for a certain amount (ex- 100 cr) and may have to pay the amount in a short time which
may not be possible at that time.

- Therefore, the Indian businessman approaches a bank in India and submits security worth
roughly the same amount as the fee he is due to pay, and in return asks his bank to issue an LOU.

- The bank issues an LOU and sends a message to the supplier’s bank through SWIFT, guaranteeing
money owed by the Indian businessman. This ensures the smooth conclusion of the business
transaction.

- In the case of PNB, the LOU’s were issued in favour of Nirav Modi bypassing the bank’s reporting
system using SWIFT messages to overseas banks without authorization. Nirav Modi, with the
assistance of senior PNB officials, was able to obtain LOUs without submitting any securities.
These LOUs were then submitted via SWIFT messages to banks in other countries.

How the perpetrators got caught

- According to a 2018 article by the Hindustan Times, for the past seven years, two employees of
PNB were sending unauthorised LOUs. This was until one of them retired and a new employee
joined in his place.

- In January, when Nirav Modi’s firm asked for a fresh set of guarantees, the new employee
demanded collateral. The representatives from Firestar (Nirav Modi and co) responded by saying
that they had never been asked for a guarantee in the past. This triggered an investigation which
led to the curtains falling and the truth of the fraudulent LOUs coming to light
Fugitive Economic Offenders Act (2018)

- In response to the huge bank scam, the government passed the Fugitive Economic Offenders Act
(2018) which came into force on 21st April 2018.

- The Act was enacted to prevent economic offenders in the ilk of Nirav Modi from escaping the
country. Courts are empowered under this Act to confiscate all assets and properties of the
offenders who are charged with default over Rs. 100 crores and those who try to evade the
charges by wilfully remaining outside the jurisdiction of the Indian judiciary.

- In accordance with this Act, the fugitive economic offender’s property and other valuable assets
are confiscated.

Legal angle

- Fraud is essentially defined as any dishonest act or behaviour by which a certain individual gains
or has the explicit intent to gain an advantage over another person. In a fraud, the loss caused to
the victim is either directly or indirectly.

- While fraud is not described or discussed in a detailed manner in The Indian Penal Code, there
are certain sections dealing with the constituents of fraud. This includes cheating, concealment,
forgery counterfeiting and breach of trust.

- In a contractual sense, fraud refers to and includes any acts by a party to a contract or with his
expressed authority or instructions or by his agents with the intention to deceive another party
or his agent or to induce them to enter into a contract. All of this is read in accordance
with section 17 of the Contract Act.

- In the modern age, banking fraud is on the rise and more prevalent than ever. Compared
to ordinary cases of thefts and robberies, the amount misappropriated in crimes like banking
fraud runs into lakhs and crores of rupees. Bank fraud is by law a federal crime in most countries.
Simply put, banking fraud is the use of potentially illegal means to obtain money, assets, or other
property owned or held by a financial institution, or in some cases to obtain money
from depositors by fraudulently posing as a bank or some other financial institution.

Impact and resulting aftermath

- PNB was essentially left holding bank guarantees worth in excess of Rs 11,400 crore which it has
to pay to a multitude of different parties including the State Bank of India, Allahabad Bank and
Union Bank. The said payments were expected over the next few months.

- Furthermore, the banking sector, jewellery sector and the insurance sector were stunted with
serious negative repercussions after the findings of the case were reported to the public.

- Big questions arose with regard to the credibility of public sector banks as a whole, and also the
whether regulators like the RBI and SEBI were performing their duties to the required standard.

- In response to all this, the Reserve Bank of India immediately banned banks from issuing
guarantees in the form of letters of undertaking (LOU) to prevent any further misuse of the
medium. It was also decided that the process of issuing LoUs for trade-related credits for
 imports in India was to be discontinued by commercial banks with immediate effect. The RBI had
also directed banks to connect their core banking systems (CBS) to the SWIFT (Society for
worldwide interbank financial telecommunication) system by April 30, of that. Meanwhile, Nirav
Modi was charged with criminal conspiracy, cheating, dishonesty, fraud, breach of trust and
breach of contract and was arrested in London after the release of an arrest warrant against him.

Impact on the Stock Market

• The overall value of PNB’s fraudulent transactions was said to be nearly 50 times that of the
bank’s 2018 end third-quarter net profit of Rs 230.11 crores. In particular, there were five
notable banks that had been directly impacted by the fraud as they had offered credit based on
the LoUs that had been issued at the behest of PNB. The said institutions were UBO bank,
Allahabad Bank, Axis Bank, Union Bank of India.

• Union Bank of India: UBI is said to have suffered a reported loss of 5.8 per cent that led to Rs
633 crores of erosion in its overall market capital at the time (that is, between 12 February
closing and 15 February closing). Overall the bank’s negative stock exposure as a result of the
PNB fraud stood at a total of Rs 1920 crores. The bank was also reported to have suffered a net
loss of Rs 1,249.85 crores in Q3FY18. It’s Gross NPAs stood at 13.03 per cent in Q3FY18
compared to 11.7 per cent in Q3FY17.

• Allahabad Bank: The bank saw a stock price drop of over 9.9 percent that continued till the 15th
of February 2018. Moreover, Its market capitalization was said to have suffered an erosion of
over Rs 484 crores. The bank’s overall exposure in PNB fraud was calculated as being roughly Rs
2400 crores. In Q3FY18, the bank reported a 5.4 per cent reduction in total income with a net
loss of Rs 1263.79 crores. Its gross non-performing assets were also said to have skyrocketed to
the value of 14.38 per cent in Q3FY18 in comparison with the reported to 12.51 per cent in
Q3FY17.

• Axis Bank: The share price of Axis Bank fell by roughly 3.4 per cent, this downward spiral on up
to to 15 February 2018, also, the overall market value was also said to have fallen reportedly by
over Rs 4,800 crores. Finally,The bank’s overall exposure in PNB fraud is said to be around Rs 200
crore.

• SBI: The State bank of India saw shares plummet by 3.34 per cent, with there being an overall
market value drop of over Rs 8,329 crores between the time period of 12 February 2018 and 15
February 2018. Also, its reported exposure to the PNB fraud was calculated to be at 1360 crore.
In Q3FY18, the state bank of India was hit with a net loss of Rs 2416 crores compared to the Rs
2610 crores profit in Q3FY17. Furthermore, its gross Non-performing Assets soared from 7.23
per cent in Q3FY17 to a reported high of 10.35 per cent in Q3FY18.

Impact on LIC

• While dealing a deadly blow to major Indian banks, it also had a strong impact on another state-
owned entity, the Life Insurance Corporation. LIC, which lost a reported amount of Rs 1,400
crore.

Impact on Jewellery Stocks

 • In lieu of the shocking developments, the shares of Gitanjali Gem fell by a reported 19 per cent
soon after Punjab National Bank’s declared the news of the fraud to the wider public. Also, the
stocks of other publicly listed jewellery traders suffered a hit with PC Jeweller witnessing a 19.50
per cent slump to Rs 303.00, Tribhovandas Bhimji Zaveri (TBZ) a recorded 4.32 per cent to Rs
110.60, and Thangamayil Jewellery fell by 2 per cent to 558.55 on BSE. Rajesh Exports was also
hit by 1.34 percent to a recorded plummet of Rs 808.70 on the BSE

Reforms and lessons learnt

• The scam pushed forward the catalyst for a slew of major reforms in the Punjab National bank. It
has also seen a recent uprise in the bank’s performance across different indicators. The PNB had
a score of 78.4 out of 100 and was ranked first in the EASE (Enhanced Access & Service
Excellence)index, According to the report PNB displayed “strong performance” in areas like
customer responsiveness, responsible banking, credit off-take and financial inclusion.

Stated below are some of the lessons learnt from the bank scam:

• The first notable realization was that banks urgently needed to better manage their
operational risks, essentially in the realm of credit, market and operation risks.

• Credit risk (CR) and market risk (MR) are primarily related to potential losses from lending and
investment activities respectively. Losses of this nature occur in a situation where there is a
loan default or wrong valuation value of an investment.

• Then we have Operational risk (OR) which works to indicate a failure in any of the banking
systems, processes and also the people. OR covers a broad range of products and businesses,
in contrast to CR or MR, which are focused on specific transactions.

• Also, we must look beyond the banks. It has to be understood that various agencies also need
to make changes to their existing behavioural patterns and attitudes in the field, they must
immediately sharpen and update their skills and knowledge of the banking business.
Furthermore Internal, as well as statutory, auditors must be capable and also willing to
highlight any inadequate processes or potential malpractices being followed by a banking
institution. Even if certain specific transactions may manage to slip away undetected, the
checking of the loan approval process and its issuance is a must which auditors have to take
accountability for.

• Thirdly, there is something for the Reserve Bank of India to learn as well. It is undeniable that
The Reserve Bank of India (RBI) has been efficient in issuing all the requisite guidelines
pertaining to CR, MR and OR. However, it also needs to promote better discipline in OR as so
as to ensure better success in its supervisory duties. Moreover, The process of reporting Red
Flagged Accounts (RFA) needs to be tested to see whether the correct balance between type-
1and type-2 errors is being adopted by the banks in this process.

• Finally, the Government of India, as a public policy leader and plan developer, should evaluate
the chinks in its armour that have to lead to mishaps such as these. Furthermore it is
necessary that the Ministry of Corporate affairs (MCA) take time to carefully review various
factors like the disclosure standards of corporates, including banks. However, rather than
merely making increases in the number of compliances, the MCA must also carry out a wider
review of the disclosure and compliance process, to ensure that the process is as effective and
error-free as possible.
 UNIT 7
Auditing and Internal Audit in Companies

Role of Auditors

• A company relies on external capital for its operations, and the investors or
stakeholders have a vested interest in ensuring that their investments are secure.
They want to ensure that the company’s resources are being used for their
intended purposes and that the financial statements reflect a true and fair view of
the company’s financial position.
• Auditing is essential for providing independent verification that the accounts
of the company represent the actual state of affairs. Auditors help in detecting
frauds, technical errors, and errors of principle that may arise in financial
reporting.
• Auditors play a critical role in verifying financial records, ensuring
compliance with tax laws, detecting discrepancies in accounting practices, and
advising companies on improving operational efficiency.
• Under The Companies Act, 2013, a person can only be appointed as an
auditor of a company if they are a Chartered Accountant and a member of the
Institute of Chartered Accountants of India (ICAI). If the auditor is a firm, the
majority of its partners must also be qualified as per the Act.

Responsibilities of an Auditor

• Detection of Fraud: An auditor’s role extends to identifying potential fraud.

However, discovering fraud is not the primary objective of an audit. The auditor
must evaluate whether any fraud, if material, could affect the financial statements.
If a fraud is discovered after the audit has concluded, it does not necessarily imply
negligence or incompetence by the auditor. The auditor is only held responsible if
due diligence was not observed in conducting the audit.
• Audit Objectives: The primary purpose of an audit is to evaluate the true
and fair view of the company’s financial statements. Detection of fraud is an
incidental objective. If fraud is sufficiently material, it may influence the auditor’s
opinion on the financial statements.

Internal Audit under Section 138

 • According to Section 138 of the Companies Act, 2013, certain classes of
companies are required to appoint an internal auditor who could be a chartered
accountant, a cost accountant, or another professional. The appointment of an
internal auditor is mandatory for:
• Every listed company.
• Unlisted public companies with a paid-up capital of ₹50 crore or more, or a
turnover of ₹200 crore or more, or outstanding loans or borrowings
exceeding ₹100 crore, or outstanding deposits exceeding ₹25 crore.
• Private companies meeting similar criteria regarding turnover or
borrowings.
• The Central Government can prescribe the manner and intervals at which
the internal audit should be conducted and reported.

Appointment of Auditors under Section 139

1. First Appointment: Every company must appoint an auditor at its first

Annual General Meeting (AGM). The auditor will hold office from the
conclusion of the 1st AGM until the 6th AGM.
2. Re-appointment: The appointment of auditors should be ratified at each
AGM. Before appointment, the company must obtain written consent from the
auditor and a certificate regarding the criteria of appointment under Section 141.
3. Rotation of Auditors:
• Listed companies cannot appoint or re-appoint an individual auditor for
more than one term of 5 consecutive years.
• Audit firms can be appointed for only two terms of 5 years each.
• The audit partner and audit team may rotate as per the company’s
resolution.
4. Casual Vacancy: If an auditor vacates their position due to death, resignation,
or disqualification, the Board of Directors must fill the vacancy within 30 days.
The appointment must also be approved by the company at a general meeting
within three months.
5. Reappointment of Retiring Auditor: A retiring auditor may be re-appointed
at the AGM unless:
 • The auditor is disqualified.
• The auditor has expressed unwillingness to be re-appointed.
• A special resolution has been passed to appoint another auditor.
6. Government Companies: For a Government company, the Comptroller
and Auditor-General of India appoints the first auditor. If not appointed within
60 days, the Board appoints the auditor within the next 30 days. If the Board
also fails, the members must appoint the auditor within the following 60 days.

Key Provisions in Section 139 (Appointment of Auditors)

• If no auditor is appointed or re-appointed at an AGM, the existing auditor

continues in office.
• For companies required to form an Audit Committee under Section 177, all
auditor appointments, including casual vacancies, must be made after considering
the recommendations of the Audit Committee.

Summary

Auditing ensures that companies are accountable for their financial practices and
that stakeholders’ interests are protected. The role of the auditor has evolved to
include ensuring compliance, detecting fraud, and providing valuable advice on
efficiency improvements. Internal audits, as mandated by the Companies Act,
provide an additional layer of scrutiny, particularly for larger companies. The
appointment and rotation of auditors are critical to maintaining transparency and
avoiding conflicts of interest, while statutory requirements ensure that audits are
conducted with independence and due diligence.
Removal, Resignation, and Qualifications of Auditors under the
Companies Act, 2013

Removal of Auditor (Section 140)

• Before Term Expiry: An auditor can be removed before the expiry of their
term only by a special resolution passed by the company. However, the Central
Government’s prior approval is required for such removal.
• Opportunity to Be Heard: The auditor must be given a reasonable
opportunity to be heard before their removal.
 • Resignation: If an auditor resigns, they must file a statement within 30 days
from the resignation date with the company, the Registrar, or the Comptroller
and Auditor-General of India (in case of government companies), detailing the
reasons and other relevant facts.
• Penalties for Non-Compliance: If the auditor fails to file the statement, they
will be liable to a penalty of ₹50,000 or the amount equal to the remuneration of
the auditor (whichever is less). A continuing failure will incur an additional
penalty of ₹500 per day, up to a maximum of ₹2 lakh.
• Fraudulent Actions: The Tribunal, either suo motu or on application, may
direct the company to change its auditor if it finds that the auditor has acted
fraudulently, abetted fraud, or colluded with the company or its directors.

Eligibility and Qualifications of Auditors (Section 141)

• Individual Auditor: Only a Chartered Accountant (CA) can be appointed as

the auditor of a company.
• Audit Firm: If a firm (including a Limited Liability Partnership (LLP)) is
appointed as the auditor, the majority of its partners must be Chartered
Accountants practicing in India.
• Authorized Signatories: Only the partners who are Chartered Accountants
are authorized to sign on behalf of the firm.

Disqualifications of Auditor (Section 141)

A person is disqualified from being appointed as an auditor if they:

1. Are a body corporate (except LLPs).

2. Are an officer or employee of the company or any of its affiliates.
3. Are a partner/employee of the company.
4. Hold any security or interest in the company, its holding, subsidiary, or
associate company.
5. Have provided security or guarantee related to the company’s debts or the
debts of its subsidiaries or associates.
 6. Have a relative employed as a director or key managerial personnel in the
company.
7. Are employed full-time elsewhere, or a partner of a firm serving as auditor
to more than 20 companies (excluding certain small or private companies).
8. Have been convicted of fraud, and the conviction was within the past 10
years.
9. Provide management services directly or indirectly.

Remuneration of Auditor (Section 142)

• The remuneration of the auditor is typically fixed in the general meeting of

the company or by the board in the case of the first auditor.
• The auditor is entitled to remuneration for out-of-pocket expenses incurred
during the audit and any additional services rendered at the company’s request.

Auditor’s Right to Attend General Meeting (Section 146)

• The auditor must receive notices of all general meetings and has the right
to attend the meetings, either personally or through an authorized representative.
• The auditor has the right to be heard at the meeting on any matter related to
their duties as an auditor.

Duties of an Auditor (Section 143)

• Right of Access: An auditor has the right of access to the company’s books
of account and supporting vouchers at all times. This access extends to records
kept at the registered office or any other location.
• The auditor is entitled to ask the company’s officers for any information
required to perform their duties.

Summary

The Companies Act, 2013, establishes clear guidelines for the appointment,
removal, and resignation of auditors. An auditor must meet certain eligibility
criteria and adhere to strict disqualification conditions to maintain their
independence and credibility. The remuneration of auditors is set in the general
meeting, and they are given extensive rights to access financial records and attend
meetings to ensure transparency. Additionally, they must comply with provisions on
fraud detection and fraudulent actions related to company audits, with penalties
in place for non-compliance.

The Companies Act, 2013 outlines various responsibilities, liabilities, and

restrictions regarding auditors, including their duties to report on financial
statements, branch offices, frauds, and other specified areas.

1. Audit Report on Financial Statements

The auditor must report on financial statements laid before the company in a
general meeting, ensuring compliance with accounting and auditing standards. The
report should include:

• Verification of information and explanations sought for the audit.

• Confirmation that proper books of account have been maintained.
• Agreement of balance sheet and profit & loss accounts with books.
• Compliance with accounting standards.
• Observations on adverse financial matters and internal controls.
• Reporting of disqualified directors and any qualifications or reservations on
account maintenance.
• Confirmation that the financial statements reflect accurate operations.

2. Audit Report for Government Companies

For government companies, auditors must follow directives from the Comptroller
and Auditor General (CAG) of India. Any directions from the CAG, along with their
effects, must be included in the report. The CAG has the right to conduct a
supplementary audit and provide comments, which must be sent to stakeholders
and included in the annual general meeting.

3. Branch Audit
Where a company has branch offices, auditors must ensure the branch accounts are
audited by either the company’s auditor or a qualified individual in the relevant
country. The branch auditor prepares a report, which is reviewed by the company’s
auditor.

4. Compliance with Accounting Standards

Auditors must ensure that the audit is conducted according to accounting standards
prescribed by the government, with consultation from the National Financial
Reporting Authority (NFRA).

5. Reporting Fraud

Auditors must report any fraud they suspect is occurring within the company to the
Central Government. This is a critical responsibility and must be done in good faith,
without breaching other duties under the Companies Act.

6. Duty to Sign Reports

Auditors are required to sign audit reports and certify the accuracy of financial
statements. Any qualifications or adverse remarks about the company’s financial
matters must be read aloud in the general meeting and be available for inspection
by members.

7. Liabilities of Auditors

Auditors face civil and criminal liabilities for their actions:

• Civil Liabilities: Include negligence and misfeasance. An auditor may be held

responsible for losses caused due to their failure to exercise reasonable care or
perform their duties correctly.
• Criminal Liabilities: Include penalties for non-compliance with provisions of
Sections 139, 146, or failure to report fraud. Auditors who deceive or mislead the
company or its stakeholders can face imprisonment and substantial fines.
• Fraudulent Actions: If an auditor colludes in fraud, the National Company
Law Tribunal (NCLT) can remove the auditor, and the Central Government can
appoint a new one. Further, the auditor is barred from appointment for five years.
8. Penalties for Non-Reporting Fraud

Failure to report fraud as required by Section 143 leads to a fine ranging from Rs. 1
lakh to Rs. 25 lakh. If the auditor commits fraud, they are liable for imprisonment (6
months to 10 years) and a fine up to three times the amount involved in the fraud.

9. Class Action

Under Section 245, any 100 or more members, or 10% of the total members or
deposit holders, may file a class action suit against an auditor for making improper
or misleading statements in the audit report, or for fraudulent actions. The liability
extends to the audit firm and individual partners involved.

10. Prohibited Services

Section 144 prohibits auditors from providing certain services, including:

• Accounting, internal auditing, actuarial, investment advisory, and

management services.
• Design or implementation of financial information systems.
• Outsourced financial services.

These restrictions ensure auditors maintain independence and avoid conflicts of

interest while performing their duties.
The provisions you’ve provided detail several important aspects related to the
signing of audit reports, punishments for contraventions, and the role of audit
committees, along with the updated Companies (Auditor’s Report) Order (CARO)
2020.

Signing of Audit Reports - Section 145

• Auditor’s Responsibility: The auditor is required to sign the auditor’s report

for the company. Any qualifications or comments in the audit report that may
adversely affect the company’s functioning must be presented at the general
meeting of the company and be open to inspection by any member.

Punishment for Contravention – Section 147

 1. For the Company:
• If sections 139 to 146 (related to auditors and audits) are contravened, the
company can face a fine of Rs. 25,000 to Rs. 5,00,000.
• Every officer in default may face imprisonment of up to 1 year, or a fine
ranging from Rs. 10,000 to Rs. 1,00,000, or both.
2. For the Auditor:
• If an auditor contravenes any provisions of sections 139, 143, 144, or 145,
they can face a fine ranging from Rs. 25,000 to Rs. 5,00,000, or up to four times
the remuneration, whichever is lower.
• For willful contravention, the auditor may face imprisonment up to 1 year
and a fine ranging from Rs. 1,00,000 to Rs. 25,00,000, or up to eight times the
remuneration, whichever is lower.
• The auditor must also refund their remuneration and may be required to pay
damages for loss arising from incorrect statements in their audit report.
3. For Audit Firms:
• If an audit firm’s partners are involved in fraudulent activities, the civil or
criminal liability falls jointly and severally on the partners and the firm.

Audit Committee – Section 177

• Constitution of Audit Committee: Every listed public company must have

an audit committee with a minimum of three directors, with independent
directors forming the majority. They must have the ability to read and understand
financial statements.
• Roles of the Audit Committee:
• Recommendations for the appointment and remuneration of auditors.
• Review of the auditor’s independence and effectiveness.
• Examination of the financial statements and auditor’s reports.
• Approval of related-party transactions.
• Investigation into any matter and the power to access company records and
obtain professional advice.
 • Reporting: The board must disclose the composition of the audit committee
and any disagreements with the committee’s recommendations.

Companies (Auditor’s Report) Order, 2020 (CARO 2020)

• Purpose: CARO 2020 replaces CARO 2016 and introduces enhanced

reporting requirements for statutory audits. The aim is to improve the overall
quality of audit reports.
• Applicability: It applies to statutory audits starting from 1 April 2021 for the
financial year 2020-21, except for certain companies (e.g., one-person companies,
small companies, banking companies, charitable companies, etc.).

Reporting Requirements Under CARO 2020

The auditor’s report must cover:

• Tangible and intangible assets details.

• Inventory and working capital information.
• Details of loans, guarantees, and advances.
• Compliance with statutory deposit and loan requirements.
• Fraud and whistle-blower complaints.
• Related party transactions and internal audit systems.
• Material uncertainties or negative responses and their basis.
• Resignation of statutory auditors and other critical matters.

The new provisions emphasize more transparency and accountability in the audit
process, ensuring that the audit report gives a clearer picture of a company’s
financial health and operations.
The National Financial Reporting Authority (NFRA) is a significant body created
under Section 132 of the Companies Act, 2013, with its formation coming into
effect on 1st October 2018. The main objectives and functions of the NFRA are
aimed at enhancing the quality of financial reporting and auditing practices in India,
building investor confidence, and ensuring compliance with accounting and auditing
standards.

Purpose and Responsibilities of NFRA

• Regulation and Recommendations:

• The NFRA is tasked with making recommendations on accounting and
auditing standards.
• It monitors and enforces compliance with these standards and oversees the
quality of service provided by professionals like auditors and CFOs.
• Shift in Roles:
• The NFRA has taken over the role previously held by the National Advisory
Committee on Accounting Standards (NACAS), and the Institute of
Chartered Accountants of India (ICAI) now consults with the NFRA when it
comes to recommending accounting standards.
• Additional Functions:
• It aims to improve the quality of auditing and other professional services and
takes measures to ensure compliance with relevant standards.

Powers of NFRA

• Investigation Powers:
• The NFRA can investigate professional misconduct by CA firms or individual
CAs. It can initiate investigations either suo motu (on its own initiative) or
based on a reference from the Central Government.
• The NFRA has powers similar to a Civil Court under the Code of Civil
Procedure to:
• Discover and produce documents.
• Summon and examine individuals under oath.
• Inspect documents and records.
• Issue commissions to examine witnesses.
• Punishment for Misconduct:
 • Individuals found guilty of professional misconduct may face fines between
Rs. 1,00,000 and 5 times the fees received.
• Firms found guilty may face fines between Rs. 5,00,000 and 10 times the
fees received.
• The NFRA can also debar a member or firm from practice for periods ranging
from 6 months to 10 years.

Key Provisions under NFRA Rules, 2018

• Monitoring Auditors:
• The NFRA can review working papers, audit plans, and quality control
systems of auditors. It can direct auditors to improve their audit processes and
quality control systems and may monitor the progress made.
• It can also oversee governance practices and internal processes of auditors to
ensure audit quality and reduce failure risks.
• Public Reporting and Confidentiality:
• The NFRA publishes findings relating to non-compliance on its website,
though it may withhold proprietary or confidential information unless it is in
the public interest to disclose.
• The Authority may report violations involving fraud worth Rs. 1 crore or
more to the Central Government.

Investigation and Enforcement

• Initiating Investigations:
• The NFRA can investigate matters of misconduct based on a reference from
the Central Government or suo motu decisions. It can take enforcement actions
and provide recommendations for further legal or professional proceedings.
• Fraud Reporting:
• If evidence of fraud worth Rs. 1 crore or more is found, the NFRA is required
to report it to the Central Government for further action.

Impact on the Profession

 • The NFRA significantly strengthens oversight and accountability within the
auditing profession in India. By directly investigating auditor misconduct and
overseeing the enforcement of auditing standards, the NFRA is expected to elevate
the quality of financial reporting and auditing practices, thus protecting public and
investor interests.

In essence, the NFRA plays a crucial role in shaping the audit landscape by ensuring
higher standards of professional conduct and addressing misconduct effectively. It
serves as a regulatory authority with both investigative and corrective powers,
aimed at fostering a trustworthy financial reporting ecosystem.

Section 11 - Disciplinary Proceedings (NFRA Rules 2018)

The National Financial Reporting Authority (NFRA) has established rules for
disciplinary proceedings that can be initiated against auditors or audit firms when
there is a belief that there has been misconduct or non-compliance. These rules
include the following key points:

1. Show-Cause Notice:
• If sufficient cause is identified through monitoring, enforcement, oversight
activities, or from material on record, the NFRA refers the matter to the
concerned division.
• A show-cause notice is issued to the auditor, which must include:
• A detailed explanation of the alleged issues.
• Copies of relevant documents and extracts from the investigation
report.
• The notice is served by registered post or electronic means to the
auditor’s address or email.
2. Response and Disposition:
• The auditor has the right to respond within a specified period.
• The concerned division must dispose of the notice within 90 days and issue a
reasoned order.
• The order may provide for:
 • No action
• A caution
• A penalty
3. Effective Date of the Order:
• The order will become effective after 30 days from its issuance, unless the
division states otherwise with reasons.

Auditors’ Responsibilities within the Organization

There are two primary types of auditors: internal auditors and external auditors.
Both play critical roles in ensuring the accuracy and reliability of financial
statements but with different responsibilities:

1. Internal Auditors:
• Employed by the organization and are primarily responsible for evaluating
internal controls, risk management, and compliance with policies.
• They focus on identifying misstatements or irregularities within financial
records and report these to management for corrective action.
2. External Auditors:
• Independent entities or firms hired to review the organization’s financial
statements.
• They focus on identifying material misstatements to provide an audit
opinion on the financial statements, ensuring that they give a true and fair view
of the organization’s financial health.

Both auditors must demonstrate efficiency in identifying misstatements, and this

improves with experience in the relevant industry. Internal auditors typically
report to management, while external auditors report to stakeholders through
the audit report.

Auditors in Corporate Governance

Though auditors are not directly involved in management, they play a significant
role in corporate governance by ensuring that the organization adheres to ethical
and financial standards. Their roles include:

1. Incorporation in the Audit Plan:

• Auditors help provide insight into the organization’s direction and control,
highlighting areas where the management may be overlooking stakeholder
interests. This fosters better corporate governance through transparent
information sharing.
2. Accountability:
• By identifying material misstatements, auditors encourage management to
hold individuals accountable for their actions, which can reinforce the
organization’s control processes.
3. Check on Corporate Governance:
• Although auditors do not have the responsibility to ensure efficient corporate
governance, they monitor areas where weak governance could lead to financial
misstatements. Open communication between auditors and management is key
to addressing governance issues.
4. Internal Auditors’ Contribution:
• Internal auditors are integral to corporate governance. Their close
relationship with management allows them to identify stakeholders’ interests
and conflicts, which they can help management navigate for better governance.
5. Risk Management:
• Auditors contribute to risk management by assessing potential risks during
audits. The knowledge that auditors are actively checking for risks encourages
management to adopt stronger risk management strategies, contributing to
overall governance quality.

Summary

The NFRA’s disciplinary procedures and rules for auditors emphasize

accountability, transparency, and compliance with auditing standards. The auditors
themselves, whether internal or external, play pivotal roles in corporate governance
by ensuring that the organization operates ethically, manages risks effectively, and
upholds stakeholder interests.
Unit 8
Securities and Exchange Board of India (SEBI) - Listing Obligations and Disclosure Requirements
(LODR) Regulations, 2015

Introduction and Purpose

• SEBI's LODR Regulations, 2015 were introduced to promote transparency, accountability, and
governance among listed public companies.

• These regulations apply to all listed entities, aiming to establish a robust corporate governance
framework and ensure adequate disclosure of important information.

• Primary objectives include:

o Strengthening corporate governance by setting clear obligations for listed companies.

o Reducing compliance burden for listed entities through streamlined processes.

o Ensuring consistency by harmonizing LODR provisions with the Companies Act, 2013.

o Promoting inclusivity by adopting gender-neutral language, removing redundancies, and

simplifying regulatory text.

Key Developments and Scope

• Date of Notification: The LODR Regulations were notified on September 2, 2015, following a
period of extensive consultations.

• Consolidation of Requirements: The regulations integrated and organized requirements

previously scattered across listing agreements for different segments of the capital market.

• Latest Amendments: In 2023, substantial amendments were made to the LODR, effective
primarily from July 14, 2023, with the focus on enhancing governance and transparency.

Key Changes in 2023 Amendments

1. Disclosure Framework:

o Introduced objective criteria for defining "material events/information."

o Reduced timelines for making disclosures.

o Required additional disclosures for agreements binding listed entities and addressing
market rumors.

2. Special Rights for Shareholders:

o Set new disclosure and approval requirements for special rights granted to
shareholders.

3. Business Transfer Agreements:

 o Introduced approval requirements for business transfer agreements executed outside
the scheme of arrangement route.

4. Board Seats and Vacancies:

o Defined the validity of permanent board seats and stipulated timelines for filling
vacancies of directors and Key Managerial Personnel (KMPs).

Rationale and Applicability of LODR Provisions

• The regulations acknowledge that market capitalization is dynamic and that entities may move
in and out of defined categories as their market capitalization, paid-up capital, or net worth
changes.

• Instances were observed where entities, upon meeting certain thresholds, complied with LODR’s
corporate governance requirements, only to cease compliance if their metrics fell below the
required levels.

• Proposal for Consistency: To uphold corporate governance standards, it was proposed that
once an entity meets LODR requirements, it must continue complying with those standards,
irrespective of subsequent fluctuations in market capitalization, paid-up capital, or net worth.

o This approach ensures that compliance does not stop when thresholds are no longer
met, preventing governance standards from being inconsistently applied.

Regulation 30: Disclosure of Events or Information

Overview

• Regulation 30 mandates that every listed entity must disclose events or information deemed
material by the board of directors.

• Material Information as per Schedule III includes significant corporate actions and events that
can affect the company’s value or influence investor decisions.

Types of Material Information (Schedule III)

1. Acquisitions and Restructuring:

o Any acquisition (including agreements to acquire), restructuring through mergers,

demergers, amalgamations, or sale/disposal of units, divisions, or subsidiaries.

2. Securities-Related Changes:

o Issuance or forfeiture of securities, share splits or consolidations, buybacks, restrictions

on transferability, and alterations in securities structure.

3. Rating Revisions:

o Changes to the company’s credit rating.

4. Board Meeting Outcomes:

 o Decisions regarding dividends, capital changes, financial results, management changes,
and agreements must be disclosed within 30 minutes of the meeting's conclusion.

5. Share Transfer Agent Changes:

o Appointments or discontinuations of share transfer agents.

6. Loan Restructuring or Settlement:

o Resolution or restructuring of loans from financial institutions, or one-time settlements

with banks.

7. Legal Proceedings:

o Filing of winding-up petitions by creditors or any third party.

8. Communications to Stakeholders:

o Issuance of notices, resolutions, call letters, or circulars sent to shareholders, creditors,

or debenture holders.

9. Meeting Proceedings:

o Proceedings of annual and extraordinary general meetings.

10. Corporate Resolutions:

o Amendments to the memorandum and articles of association.

11. Corporate Insolvency Resolution Process (CIRP):

o Updates or developments in CIRP.

Criteria for Determining Materiality

• The following subjective criteria guide materiality assessments:

o Public Disruption: If omitting an event or information might alter information that is

already publicly available.

o Market Reaction: If omitting information is likely to provoke significant market reaction

upon later discovery.

o Board’s Opinion: Events or information not falling under other criteria may still be
material if the board of directors considers them important.

Policy and Responsibility for Disclosure

1. Materiality Policy:

o Each listed entity must create a materiality determination policy, approved by the board,
and publish it on the entity's website.

2. Authorization of KMPs:
 o The board should appoint one or more Key Managerial Personnel (KMPs) to determine
material events and handle disclosures, providing the stock exchange with their contact
information.

3. Continuous Updates:

o Disclosures must be updated regularly with relevant explanations until the event is
resolved or closed.

4. Website Disclosure:

o Material disclosures made to stock exchanges must also be available on the company’s
website for at least five years, followed by archiving as per the entity’s policy.

Disclosure for Subsidiaries

• The company must also disclose material events or information relevant to its subsidiaries,
where such information impacts the listed entity.

Responding to Stock Exchange Queries

• The listed entity is required to provide clear responses to any stock exchange queries regarding
disclosed events or information.

o Stock exchanges will disseminate the responses promptly.

Proactive Disclosure

• Listed entities can independently confirm or deny reported events or information in

communication with stock exchanges, promoting transparency.

Disclosure Framework – Regulation 30 with Schedule III

Objective of Disclosure Framework

Schedule III of the Companies Act, 2013 outlines the preparation guidelines for a company’s financial
statements, including the balance sheet, profit and loss statement, cash flow statements, and related
notes.

A. Objective Criteria for Determining Materiality (Regulation 30(4) and Paragraph B, Part A of Schedule
III)

• Listed entities must disclose events/information that exceed certain thresholds:

o 2% of turnover, as per the last audited consolidated financial statements.

o 2% of net worth, as per the last audited consolidated financial statements (except where
net worth is negative).

o 5% of the average profit or loss after tax from the last three audited financial
statements.

• Purpose: To address inadequacies in disclosures which are often delayed or incomplete, SEBI
now requires timely disclosures without subjective assessment.
 • Background: SEBI has previously taken action against companies for nondisclosure of material
events (e.g., tax demands or lender objections), with these new rules designed to minimize
ambiguities.

B. Mandatory Disclosure of Continuing Events or Information

• Previously Undisclosed Events: Events that met subjective criteria may now require disclosure if
they meet the new objective criteria.

• Responsibility: Compliance officers must review previously undisclosed matters to determine if

they now require disclosure under the revised criteria.

C. Materiality Policy Requirements (Regulation 30(4))

• Policy Standards: A listed entity’s materiality policy should not weaken the LODR requirements.

• Employee Provisions: The policy should include a mechanism for employees to identify and
report potentially disclosable information.

• Expanded Responsibility: 2023 amendments broaden obligations for identifying and reporting
material information to company management.

D. Revised Disclosure Timelines for Material Events/Information (Regulation 30(6))

• Timeframes for disclosing material events are now shorter:

o 30 minutes after a board meeting if the event was discussed there.

o 12 hours from event occurrence if it originates within the entity.

o 24 hours from event occurrence if it originates outside the entity.

• Implications: These shortened timelines apply universally, including for both mandatory and
subjective disclosures. Entities must have internal systems for timely reporting, especially for
events initiated externally (e.g., legal actions).

E. Disclosure of Agreements Binding Listed Entities (Regulation 30A, Paragraph 5A, Part A of Schedule
III)

• Scope: Agreements involving significant parties (e.g., shareholders, promoters, related parties,
KMPs, or employees) must be disclosed if they:

o Impact the management/control of the entity.

o Impose restrictions or liabilities on the entity.

o Include obligations that influence the entity’s actions.

• Disclosure Requirement:

o If a listed entity is not a party, other parties must inform the entity, which must disclose
it with salient details and a link to the website where agreement details are available.
 o Exceptions apply for agreements within the normal course of business, but this scope
may be limited by language.

• Objectives:

1. Shareholder Transparency: Reduce information disparity.

2. Corporate Awareness: Ensure the entity is aware of obligations that affect it, though
enforceability may remain subject to privity challenges.

F. Verification of Rumors (Regulation 30(11))

• Obligations:

o From October 1, 2023, the top 100 listed entities, and from April 1, 2024, the top 250
listed entities, must confirm, deny, or clarify non-general rumors within 24 hours.

o If rumors are confirmed, entities must disclose the current stage of the event.

• Previous Practices: While the older LODR Regulations allowed voluntary confirmations, this was
rarely done; now, verification is mandatory for significant rumors.

G. Additional Disclosure Requirements (Paragraphs A and B, Part A of Schedule III)

Entities must disclose:

1. Material announcements via social or mainstream media by directors, promoters, or senior

management.

2. Frauds, defaults, or arrests involving promoters, directors, or senior management.

3. Regulatory Actions or Notices: Including investigations, search and seizure, debarments, and
suspensions.

4. Detailed Reasons for KMP Resignations.

5. Indisposition or Unavailability of the MD or CEO for a specified period.

6. Voluntary Revisions to financial statements or the board’s report.

Regulation 17 – Board of Directors Requirements

1. Board Composition

o Structure: An optimal combination of executive and non-executive directors, with at

least one woman director.

o Non-Executive Requirement: At least 50% of the board must consist of non-executive

directors.

o Independent Directors:

▪ If the chairperson is a non-executive director, one-third of the directors should

be independent.
 ▪ If there is no regular non-executive chairperson, at least half of the board should
be independent directors.

2. Meeting Frequency and Quorum

o Meetings: The board must meet at least four times annually, with a maximum gap of
120 days between meetings.

o Quorum: One-third of the board’s total strength.

3. Responsibilities

o Compliance Oversight: Review compliance reports and rectify non-compliance

instances.

o Succession Planning: Ensure plans are in place for board and senior management
succession.

o Code of Conduct: Establish a code for directors and senior management.

o Compensation: Board-decided fees and compensation for independent/non-executive

directors, requiring AGM approval. Independent directors are not entitled to stock
options.

o Risk Management: Make risk assessment procedures known, including framing,

implementing, and monitoring risk management plans.

4. Evaluation and Limits on Directorships

o Independent Directors: Evaluated by the board based on performance and

independence criteria.

o Directorship Limits:

▪ Maximum of 7 directorships per person in listed entities.

▪ Whole-time or managing directors can serve as independent directors in up to 3

listed entities.

5. 2023 Amendments

o Director Tenure Review: Starting April 1, 2024, shareholders must approve a director’s
continuation every five years. Exceptions apply to:

▪ Whole-time, managing, and rotating directors.

▪ Directors appointed by court order, government nomination, financial

regulators, or lending institutions.

o Vacancy Filling:

▪ Vacancies for roles like MD, CEO, CFO, and compliance officer must be filled
within 3 months.
Regulation 18 – Audit Committee Requirements

1. Composition

o Minimum of 3 directors, with two-thirds being independent.

o Chairperson: An independent director.

o Financial Expertise: All members must be financially literate, and at least one member
should have accounting or financial management expertise.

o Secretary: Company Secretary.

2. Meetings and Quorum

o Meetings: At least four annually, with a maximum gap of 120 days between meetings.

o Quorum: Two members or one-third of the committee, with at least two independent
directors.

3. Authority and Functionality

o The committee has the power to investigate activities within its scope, request
information from employees, and seek external professional advice if necessary.

Regulation 19 – Nomination and Remuneration Committee Requirements

1. Composition

o At least 3 non-executive directors, with 50% as independent directors.

o Chairperson: An independent director who must attend the AGM to answer shareholder
questions.

2. Meetings

o The committee must meet at least once per year.

Regulation 22 – Vigil Mechanism

1. Establishment

o Every listed entity must create a mechanism for directors and employees to report
concerns, safeguarding against victimization.

2. Accessibility

o Provides direct access to the audit committee chairperson in specific or exceptional

cases.

These regulations aim to reinforce governance, transparency, accountability, and timely decision-making
within listed entities, enhancing both internal controls and investor protection.
Unit 9: Whistle Blowing
Definition and Overview

• Whistle Blowing is the act of reporting malpractices, corruption, misconduct, or

mismanagement within an organization to internal or external parties.

• It involves raising concerns about wrongdoings to either internal bodies within the organization
or independent entities associated with it.

• Whistle blowing is motivated by the belief that the public interest should take precedence over
organizational interests, and it can impact the organization, society, and the whistleblower.

Historical References and Importance

• Whistle blowing has been discussed in multiple committee reports:

o 1998 – CII Code of Corporate Governance

o 1999 – Kumar Mangalam Birla Committee

o 2002 – Naresh Chandra Committee

o 2003 – N.R. Narayana Murthy Committee

• It’s also referenced in listing agreements and the Companies Act.

• Effective whistleblower policies are essential as they not only reduce fraudulent activities but
also demonstrate an organization's commitment to good corporate governance.

Drafting an Effective Whistle Blower Policy

• Submission: The policy should be drafted by management but approved by the Audit Committee
and Board of Directors.

• Foundation: A clear and specific definition of whistle blowing forms the basis of a sound policy.

• Key Aspects to Include:

o Clear Definition: Specify who is covered by the policy.

o Non-Retaliation: Protect whistleblowers from retaliation.

o Confidentiality: Ensure that the identity of whistleblowers is protected.

o Process: Detail steps for reporting, including potential methods like phone lines, email,
hotlines, websites, or suggestion boxes.

o Communication: Clearly communicate the policy and processes to encourage reporting.

• Effective Implementation: A whistleblower policy is only effective if:

o It’s consistently implemented.

o Claims are investigated, evaluated, and acted upon.

 • Clause 49 of the Listing Agreement: While whistle blowing is a non-mandatory item under
Clause 49, it should ideally be made mandatory for better governance.

Role of Employees, Board of Directors, and Whistle Blowing

• Employee Involvement: Employees are often the first to witness wrongdoings and, despite the
risks, some choose to speak out, even if these issues are not addressed through regular
channels.

• Board of Directors and Key Management Personnel (KMP): As top management, directors and
KMPs are key to upholding integrity and ensuring that formal organizational goals align with
professional responsibility.

• Corporate Governance Officer:

o Key Responsibilities:

▪ Ensuring effective functioning of the Board and its Committees.

▪ Compliance with listing rules, regulatory codes, and acts.

▪ Monitoring legal and regulatory developments and informing directors and

management.

▪ Managing relationships with stakeholders regarding corporate governance and

social responsibility.

▪ Serving as the company’s conscience and point of contact for the Board.

▪ Assisting in decision-making and ensuring regulatory reporting is accurate.

▪ Overseeing governance processes and tracking outcomes.

Instances Requiring Whistle Blowing

The following unethical practices or improper activities should be reported:

• Theft, harassment, unethical practices, fraud, dishonesty, discrimination

• Lack of independence of the Board/Committees or auditors

• Improper director remuneration packages

• Regulatory or code of conduct violations

• Insider trading, corruption, bribery

• Workplace safety hazards

• Financial misrepresentation

• Lack of proper internal controls

Whistle Blowing in Private Employers

 • Lack of Specific Law: There is no specific whistleblowing law for private employers in India.

• Progressive Policies: Some companies have adopted whistleblower policies as part of their
global standards, covering individual employees, groups, and sometimes third parties.

• Policy Purpose: Encourage individuals to report wrongdoings without fear of victimization,

discrimination, or disadvantage.

This comprehensive approach to whistle blowing underscores its importance in promoting transparency,
accountability, and ethical practices within organizations.

Provisions Under the Companies Act, 2013 for Vigil Mechanism and Whistle Blowing

A) Section 177 - Establishing a Vigil Mechanism

1. Applicability: Section 177 mandates the establishment of a vigil mechanism in the following
types of companies:

o Listed Companies

o Companies that accept public deposits

o Companies with borrowings over ₹50 crores from banks or public financial institutions

2. Audit Committee's Role:

o Companies required to have an Audit Committee must operate the vigil mechanism
through the Audit Committee.

o If an Audit Committee member has a conflict of interest in a particular case, they must
recuse themselves, and the remaining members will handle the matter.

3. For Companies Without an Audit Committee:

o The Board of Directors should nominate a director to fulfill the role of the Audit
Committee for the vigil mechanism.

o Employees and other directors should report concerns to the appointed director.

4. Safeguards and Accessibility:

o The vigil mechanism policy must include safeguards to prevent victimization of those
using the mechanism.

o Provisions should allow direct access to the Chairman of the Audit Committee or the
nominated director (if there is no Audit Committee).

5. Disclosure Requirements:

o Details of the vigil mechanism policy should be disclosed on the company’s website and
in the Board’s report.

6. Independent Directors’ Responsibility:

 o Independent directors must ensure the vigil mechanism is adequate and functional.

o They should confirm that individuals using the mechanism are protected from prejudice
due to its use.

7. Action Against Frivolous Complaints:

o In cases of repeated frivolous complaints, the Audit Committee or nominated director

can take appropriate action against the employee or director involved.

B) Section 179(9) - Vigil Mechanism for Public Listed Companies

• Mandatory Vigil Mechanism: Section 179(9), read with Regulation 7 of the Companies
(Meetings of Board and its Powers) Rules, 2014, requires public listed companies to set up a vigil
mechanism.

• Protection for Whistleblowers: The mechanism must protect whistleblowers from harassment
or victimization and include procedures for direct access to the Audit Committee Chairperson in
exceptional cases.

• Disclosure: Publicly listed companies must publish an updated report on their vigil mechanism
on their official websites.

• 2017 Amendment: Amended Section 177 to apply to "every publicly listed company" instead of
"every listed company," mandating an Audit Committee with a vigil mechanism to support
whistleblowers in exposing illegal practices or fraud within the company.

C) Sections 208 and 210 - Investigation Powers

• Section 208: The Registrar or Inspector has authority to examine company records and submit
investigation reports to the central government.

• Section 210: Outlines the procedure for registrars and inspectors in investigating company
affairs, supporting transparency and accountability in governance.

SEBI Regulations for Whistleblower Policies

1. Whistleblower Policy Requirement:

o SEBI mandates all listed companies to have a whistleblower policy, making employees
aware of it to report leaks of unpublished price-sensitive information.

o Listed companies must disclose significant events to stock exchanges as per Regulation
30 of SEBI’s Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015.

2. Access to the Audit Committee:

o Employees must have access to the Audit Committee to report misappropriations, fraud,
or unethical behavior.

o Companies must assure employees that they have access to the Audit Committee and
are safeguarded against unfair treatment.
 3. Affirmation of Protection:

o Companies must declare that no person has been denied access to the Audit Committee,
and whistleblowers are protected from unfair treatment.

o This affirmation should be part of the annual corporate governance report.

4. Employee Rights and Protections:

o SEBI’s standards encourage employees to act responsibly, promoting vigilance against

illegal acts.

o Companies are required to protect whistleblowers from harassment or termination.

5. Reward Mechanism for Whistleblowers (Insider Trading):

o Since December 2019, SEBI has introduced a reward system for informants who report
insider trading violations.

o In 2021, SEBI increased the maximum reward for whistleblowers from ₹1 crore to ₹10
crores to incentivize disclosures.

6. Mechanism Dissemination:

o Once the mechanism is established, it should be well-publicized within the organization,

and employees should be educated on how to report unethical practices.

This detailed overview of vigil mechanisms and whistleblower protections under the Companies Act and
SEBI regulations emphasizes the importance of robust policies and safeguards to encourage transparency
and corporate responsibility.

Companies (Meetings of Board and its Powers) Rules, 2014 – Rule 7

1. Mandatory Vigil Mechanism:

o Required for all listed companies and specific classes of companies, including:

▪ Companies that accept public deposits.

▪ Companies with borrowings over ₹50 crore from banks or public financial
institutions.

2. Oversight by Audit Committee:

o Companies with an Audit Committee must operate the vigil mechanism through it.

o In cases of conflict of interest, the concerned Audit Committee member must recuse
themselves, and other members handle the case.

3. For Companies Without an Audit Committee:

o The Board must nominate a director to serve the role of the Audit Committee for the
vigil mechanism.
 o Directors and employees can report concerns directly to this nominated director.

4. Safeguards Against Victimization:

o The vigil mechanism must protect directors and employees from victimization and
provide direct access to the Audit Committee Chairperson or the nominated director in
exceptional cases.

5. Action Against Frivolous Complaints:

o In cases of repeated frivolous complaints, the Audit Committee or the nominated

director has the authority to reprimand the employee or director responsible.

SEBI’s Insider Trading Regulations (Regulation 9A (6), SEBI (Prohibition of Insider Trading) Regulations,
2015)

1. Definitions:

o Informant: An individual who voluntarily submits information to SEBI regarding insider

trading violations, either current or reasonably anticipated.

o Informant Incentive Committee: An advisory committee constituted under SEBI

regulations to handle informant-related matters.

o Irrelevant, Vexatious, or Frivolous Information: Information deemed by SEBI as

unrelated to insider trading violations, malicious, or intended to waste resources.

o Original Information: Information that:

▪ Is independently obtained by the informant.

▪ Is credible, specific, and timely.

▪ Can prompt an investigation, support ongoing investigations, or open new

inquiries.

o Reward: A monetary reward provided to informants who qualify as per SEBI’s provisions.

o Voluntarily Providing Information: Information given without any prior request from
SEBI or any government body.

Clause 49 of SEBI’s Equity Listing Agreement

1. Mandatory Whistleblower Policy:

o SEBI mandates listed companies to establish a vigil mechanism and adopt a

whistleblower policy.

2. Employee Awareness and Protection:

 o Companies must inform employees about the whistleblower policy and their right to
report unethical activities, fraud, or corruption.

o Companies must ensure protection against harassment and victimization for

complainants.

3. Reward Mechanism:

o SEBI has implemented a reward mechanism to encourage whistleblowers to come

forward.

Companies (Auditor’s Report) Order 2020 [CARO 2020]

• Mandatory Reporting of Whistleblower Complaints:

o The Ministry of Corporate Affairs requires listed companies to disclose all whistleblower
complaints to their auditors.

o Auditors must report whistleblower complaints in their published audit report,

enhancing transparency.

Whistleblowing Policies in Indian Corporates

1. Heritage Foods (India) Ltd:

o Objective: Provides employees with a platform to report unethical or improper

practices.

o Policy Features:

▪ Assumes good faith in all whistleblower communications.

▪ Requires written disclosure with supporting evidence.

▪ Safeguards whistleblower identity unless legally mandated otherwise.

▪ Investigates complaints through the management board or an independent

individual as necessary.

2. Wipro Limited:

o Ombuds Policy (Adopted April 15, 2003): Focuses on strengthening governance and
discouraging malpractice.

o Policy Features:

▪ Complaints are investigated by an Ombudsperson.

▪ Written disclosures are presumed to be made in good faith.

▪ Whistleblower identity is kept confidential to prevent retribution.

 ▪ Complaints must be filed within three months from the knowledge of
wrongdoing.

3. Reliance Industries Limited:

o Ethics and Compliance Task Force: Supervises investigations of complaints under the
Audit Committee's oversight.

o Policy Structure: Outlines clear procedures for whistleblowers to follow when reporting
misconduct.

Comparative Analysis

1. Indian vs. International Practices:

o Indian companies generally do not encourage anonymous whistleblower complaints,

unlike international companies like Deloitte and KPMG, which allow anonymity.

o Each company has unique structures and procedures for handling whistleblower
complaints, tailored to its corporate environment.

Summary

This regulatory and corporate overview highlights the importance of vigil mechanisms and whistleblower
policies in promoting corporate transparency and governance in India. The Companies Act, SEBI
regulations, and corporate practices combine to ensure that companies provide safe reporting channels
and protect employees from victimization, while also incentivizing disclosures through reward
mechanisms.

Legislative Framework Supplementing Whistleblowing Policy in the United States

1. United States False Claims Act, 1863

• The U.S. pioneered whistleblower protection with the False Claims Act of 1863, providing legal
grounds for whistleblowing.

2. Key Whistleblower Protection Legislations

The U.S. offers comprehensive protections through multiple laws, including:

• Sarbanes-Oxley Act (SOX), 2002

• Occupational Safety and Health Act, 1970

• Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010

Securities and Exchange Commission (SEC)

 • The SEC actively promotes transparency and encourages whistleblowers to report any corporate
misconduct or fraud.

The Sarbanes-Oxley Act (SOX), 2002

• Enactment and Scope:

o Enforced on July 30, 2002, SOX applies to over 40 million employees of publicly traded
corporations in the U.S.

• Audit Committees:

o Under Section 301, all public companies must establish audit committees to oversee
whistleblowing mechanisms, ensuring identity protection for whistleblowers.

o Encourages internal reporting of fraud or unethical conduct to audit committees and the
SEC.

• Protection from Retaliation:

o Employees fearing retaliation can report concerns directly to the Department of Labor
within 90 days of experiencing it.

o The Department of Labor investigates complaints and, upon completion, refers cases to
the Occupational Safety and Health Administration (OSHA) for review.

o OSHA reviews the complaint, issues findings, and enforces compliance orders.

• Legal Protections:

o SOX classifies retaliation against whistleblowers as a federal offense, punishable by fines,

imprisonment (up to ten years), or both.

o This act is crucial for whistleblower protections, providing administrative, civil, and
criminal remedies to prevent retaliation and promote safe disclosure of potential harm
to investors.

• Internal Complaint Mechanisms:

o Publicly traded companies must create internal channels for whistleblower complaints
and procedures to maintain whistleblower confidentiality.

• Attorney Whistleblowers:

o Attorneys are required to report misconduct up the ladder internally and, if

unaddressed, report externally.

• Prohibitions Against Retaliation:

 o SOX prohibits retaliation by companies or their agents against employees reporting, in
good faith, potential violations involving mail, wire, bank, or securities fraud, SEC rules,
or any law related to shareholder fraud.

o Complaints must be filed with OSHA within 180 days of discovery.

o OSHA investigates, issues determinations, and allows appeals through de novo review
before an Administrative Law Judge (ALJ) or the Administrative Review Board (ARB).

o SOX’s "kick-out" provision allows moving a case to federal court if it has been pending
with OSHA for over 180 days without a determination, provided the plaintiff or counsel
did not act in bad faith.

• Relief for Whistleblowers:

o Whistleblowers prevailing under SOX can receive reinstatement, back pay, attorney’s
fees, and costs.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010

• Extension of SOX Protections:

o Dodd-Frank enhances SOX by protecting whistleblowers who disclose corporate fraud or

misconduct, including confidential information, to the SEC or the Commodity Futures
Trading Commission (CFTC).

• Extended Protection Scope:

o Extends protections to employees of both parent and subsidiary companies.

o Increases the period to file retaliation complaints from 90 to 180 days.

• Whistleblower Reward Program:

o Section 922 authorizes the SEC to issue monetary rewards to whistleblowers who
provide original information leading to enforcement actions with sanctions exceeding $1
million.

o Rewards range from 10% to 30% of total monetary sanctions collected.

o Applies to whistleblower disclosures from July 22, 2010, onward, provided the
whistleblower complies with subsequent rules.

• Prohibitions Against Retaliation:

o Dodd-Frank prohibits retaliation, including termination, threats, demotion, suspension,

harassment, or discrimination.

o Protection applies regardless of employer awareness of the whistleblower’s reporting.

• Protected Activities:
 o Protected whistleblowing activities include:

▪ Providing original information to enforcement agencies.

▪ Participation in investigations.

▪ Required disclosures under SOX or other applicable laws.

• Nature of Information:

o Whistleblowers can submit non-publicly known information or provide insights based on

public data.

o All whistleblowers who disclose violations are rewarded, promoting transparency.

• Exclusion of “Private Right of Action”:

o Dodd-Frank does not allow whistleblowers to sue on behalf of the U.S. government.

Legislative Framework Supplementing Whistleblowing Policy in the United Kingdom

Historical Context

• During the 1980s and 1990s, the UK faced significant corporate scandals, such as the BCCI Bank
collapse and the Herald of Free Enterprise disaster, prompting legislative reforms for
whistleblower protection.

Public Interest Disclosure Act (PIDA), 1998

• Enactment and Basis:

o Formally enacted in 1999 based on the recommendations from the Nolan Committee
Report (1995).

o Provides a framework for whistleblowers to report misconduct and claim compensation

if victimized.

• Scope of Protection:

o Protects “workers” across both private and public sectors, extending protections to
contractors, suppliers, and in 2014, members of LLP partnerships as “workers.”

• Focus on Information Quality:

o The PIDA prioritizes the reliability and relevance of the disclosed information over the
identity of the whistleblower.

• Criticism and Calls for Reform:

o Critics argue the PIDA needs replacement with a law that emphasizes establishing a
robust safeguard system encouraging reporting, ensuring thorough investigation, and
protecting whistleblower identities.
Summary

The U.S. and UK have established distinct frameworks for whistleblower protection, with the U.S.
focusing on financial incentives and anti-retaliation measures and the UK emphasizing information
quality and comprehensive definitions of worker protections. These frameworks demonstrate an
evolving approach to support whistleblowers, ensuring corporate transparency and accountability.

Major Pitfalls of the Whistleblowing Policy in India

1. Scope Limitations and Ambiguity:

o India’s corporate governance framework is limited by excluding certain sectors,

particularly private companies, from mandatory whistleblower protections.

o The Whistleblower Protection Act, 2014 is limited to public companies and does not
apply to private sector companies, resulting in non-mandatory adherence to Clause 49
of the SEBI Equity Listing Agreement for these entities.

o For legislation to be effective, it must have a clear and inclusive scope.

2. Underdeveloped Legal Framework:

o India’s whistleblowing framework is still evolving and lacks a comprehensive

implementation strategy. Having a policy on paper does little to deter wrongdoing if it is
not robustly enforced and supported.

3. Trust and Awareness Issues:

o Trust is essential for effective whistleblowing, and companies should foster an

environment where employees feel secure reporting issues.

o Challenges such as distrust, lack of awareness, and misunderstandings about

whistleblower policies hinder the policy’s effectiveness.

4. Lack of Internal Investigation Procedures:

o The Act does not provide a clear framework for internal investigation processes once a
complaint is made. Without established guidelines, complaints may not be adequately
addressed.

o Recent amendments mandate whistleblowers to reveal their identities, leaving them

vulnerable to victimization and harassment and deterring potential reports.

5. Absence of Compensation Provisions:

o The Act lacks provisions for compensating whistleblowers who experience harassment
or victimization, which could dissuade employees from speaking up.
Recommendations to Strengthen the Whistleblowing Policy in India

1. Encourage Broad Adoption Across Sectors:

o Following several scandals, more companies are recognizing the importance of strong
whistleblower policies. A well-implemented framework could deter malpractices early
on.

2. Enhance Safeguards and Incentive Mechanisms:

o Companies should include mechanisms to protect whistleblower identity and reward

those who provide actionable information on company misconduct.

o Whistleblowers who provide substantial evidence of wrongdoing should receive

incentives, fostering a positive reporting environment.

3. Broaden the Scope to Include Private Sector:

o The current Act should be expanded to cover private sector entities, as it presently only
applies to cases involving public sector corruption and irregularities.

4. Strengthen Regulatory Oversight:

o Regulatory bodies should establish and enforce an efficient whistleblower policy that
prioritizes protecting the whistleblower from retaliation.

5. Integrate Whistleblower Provisions into Specific Acts:

o To reinforce whistleblower protection, relevant statutes should incorporate

whistleblowing provisions directly.

6. Promote Policy Awareness and Training:

o Management should ensure all employees are aware of the whistleblowing policy and
conduct workshops to reinforce understanding.

7. Discourage Frivolous Complaints:

o Companies should impose consequences for filing false or baseless complaints to

maintain the integrity of the whistleblower system.

Suggestive Annotations for Policy Strengthening

1. Comprehensive Definition of Whistleblowing:

o The policy should encompass a broad range of issues and cover any misconduct by
stakeholders. This ensures a wide scope of reportable matters.

2. Establish Structured Reporting Authorities:

o Design a multi-tiered reporting system, categorizing information by type and creating

authorities within organizations responsible for specific issues.
3. Prioritize Whistleblower Safety:

o Protection of the whistleblower should be central, and effective policy implementation is

measured by how well it shields whistleblowers from retaliation.

4. Government Involvement for Effective Implementation:

o Government support is crucial for high standards in policy execution, from drafting to
practical application. A government agency should oversee corporate whistleblowing
matters, potentially through the Ministry of Corporate Affairs.

5. Extend Policy to NGOs and Private Companies:

o Including NGOs and private firms in the whistleblower framework would ensure greater
transparency and accountability across all economic sectors.
Unit 10
Section 2(76), Companies Act 2013

Related Party in a company means-

- Director or his relative

- KMP or his relative

- a firm, in which a director, manager or his relative is a partner

- a private company in which a director or manager or his relative is a member or director

- a public company in which a director or manager is a director and holds along with his relatives,
more than 2% of its paid-up share capital

- any body corporate whose Board of Directors, managing director or manager is accustomed to
act in accordance with the advice, directions or instructions of a director or manager

- any person on whose advice, directions or instructions a director or manager is accustomed to

act

- any body corporate which is—

(A) a holding, subsidiary or an associate company of such company

(B) a subsidiary of a holding company to which it is also a subsidiary

(C) an investing company or the venture of a company

Section 2(77), Companies Act 2013 –

“relative”, with reference to any person, means any one who is related to another, if—

(i) they are members of a Hindu Undivided Family;

(ii) they are husband and wife; or

(iii) one person is related to the other in such manner as may be prescribed

Rule 3- Companies (Specification of definitions details) Rules, 2014.

Related party.- For the purposes of section 2 (76), Companies Act, a director other than an independent
director or key managerial personnel of the holding company or his relative with reference to a company,
shall be deemed to be a related party.

Rule 4 of the Companies (Specification of definitions details) Rules, 2014 reads as follows

A person shall be deemed to be the relative of another, if he or she is related to another in the following
manner, namely:

1. Father: Provided that the term “Father” includes step-father.

 2. Mother: Provided that the term “Mother” includes step-mother.

3. Son: Provided that the term “Son” includes step-son.

4. Son’s Wife.

5. Daughter.

6. Daughter’s husband.

7. Brother: Provided that the term “Brother” includes step-brother.

8. Sister: Provided that the term “Sister” includes step-sister.

Section 188, Companies Act 2013

- Except with the consent of the Board of Directors given by a resolution at a meeting of the Board and
subject to such conditions as may be prescribed, no company shall enter into any contract or
arrangement with a related party with respect to—

(a) sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of, or buying, property of any kind;

(c) leasing of property of any kind;

(d) availing or rendering of any services;

(e) appointment of any agent for purchase or sale of goods, materials, services or property;

(f) such related party’s appointment to any office or place of profit in the company, its subsidiary
company or associate company; and

(g) underwriting the subscription of any securities or derivatives thereof, of the company

- In case any such transaction is to be entered into, it will have to be through passing a
resolution

- no member of the company shall vote on such resolution, to approve any contract or
arrangement which may be entered into by the company, if such member is a related party

- Nothing here shall apply to any transactions entered into by the company in its ordinary course
of business other than transactions which are not on an arm’s length basis.

- Every contract or arrangement entered into shall be referred to in the Board’s report to the
shareholders along with the justification for entering into such contract or arrangement

- Where any contract or arrangement is entered into by a director or any other employee, without
obtaining the consent of the Board or approval by a resolution in the general meeting and if it is
not ratified by the Board or, as the case may be, by the shareholders at a meeting within 3
months from the date on which such contract or arrangement was entered into, such contract or
arrangement shall be voidable at the option of the Board or, as the case may be, of the
shareholders AND
 - if the contract or arrangement is with a related party to any director, or is authorised by any
other director, the directors concerned shall indemnify the company against any loss incurred by
it.

- it shall be open to the company to proceed against a director or any other employee who had
entered into such contract or arrangement in contravention of the provisions of this section for
recovery of any loss sustained by it as a result of such contract or arrangement

- Any director or any other employee of a company, who had entered into or authorised the
contract or arrangement in violation of the provisions of this section shall,—

(i) in case of listed company , be liable to a penalty of 25 lakh rupees

(ii) in case of any other company, be liable to a penalty of 5 lakh rupees

Regulation 23 - Related party transactions, LODR (gist)

- Regulation 23 of the LODR Regulations requires a company to provide materiality thresholds for
transactions beyond which approval of the shareholders through resolution will be required
and no Related Party shall vote to approve on such resolutions whether the entity is a Related
Party to the particular transaction or not.

- Every Company shall fix its materiality threshold and disclose the same to all concerned parties
of the company for the purpose of Regulation 23(4)

The provision – Regulation 23, LODR

- The listed entity shall formulate a policy on materiality of related party transactions and on
dealing with related party transactions including clear threshold limits duly approved by the
board of directors and such policy shall be reviewed by the board of directors at least once every
three years and updated accordingly – 23(1)

- All related party transactions and subsequent material modifications shall require prior approval
of the audit committee – 23(2)

- Audit committee shall provide omnibus approval for RPT of listed entity subject to following
conditions – 23(3)

i. AC to lay down omnibus approval criteria

ii. AC to make all necessary inquiries regarding omnibus approval

iii. All details to seek such approval have to be provided to AC

iv. All approvals provided to be reviewed on a quarterly basis

v. Validity of omnibus approvals is 1 year

- All material RPTs to require shareholder approval and materiality to be identified and notified by
the companies and SEBI to monitor this policy – 23(4)

- Not applicable to: 23(5)

 i. Transactions between 2 government companies

ii. Transactions between a holding company and its WOS with consolidated accounts

Regulation 23 of SEBI (LODR) Regulations 2015 – Latest Amendment

Overview of Amendments:

• SEBI amended the laws related to ‘Related Party Transactions’ (RPTs) through notifications on
November 9, 2021, and March 30, 2022, aimed at enhancing supervision and governance of
RPTs.

• Key changes take effect on April 1, 2022, and remain in effect until April 1, 2023.

Key Provisions:

1. No New Approval Required:

o Listed companies are not required to seek new shareholder approval for RPTs authorized
by the audit committee and shareholders before April 1, 2022.

2. Presentation of Material RPTs:

o RPTs approved by the audit committee before April 1, 2022, that become material under
the revised materiality threshold must be presented to shareholders at the first General
Meeting after this date.

3. Omnibus Approval:

o RPTs with omnibus approval from the audit committee must continue to be presented to
shareholders if classified as material under new standards.

4. Research Requirement:

o Listed entities are mandated to conduct thorough research on related party

transactions.

5. Disclosure Requirements:

o All transactions requiring shareholder approval must be properly identified and

disclosed in the Explanatory Statement at the first General Meeting after April 1, 2022.

Amendment Pointers:

• (i) Existing RPTs approved before April 1, 2022, do not require fresh shareholder approval.

• (ii) RPTs that continue beyond April 1, 2022, and are deemed material must be placed before
shareholders in the first General Meeting post this date.
 • (iii) RPTs with omnibus approval must be presented to shareholders if material under the new
regulations.

• Materiality Definition: An RPT is considered material if it exceeds ₹1,000 crore or 10% of the
annual consolidated turnover of the listed entity (whichever is lower), based on the last audited
financial statements.

Concerns Regarding Abusive RPTs in India

1. Regulatory Challenges:

o India struggles to balance adequate compliance to protect small investors with the need
for ease of doing business, resulting in insufficient oversight of RPTs.

2. Working Group (WG) Formation:

o SEBI formed a WG to reassess RPT regulations and provide practical recommendations.

The WG identified that companies exploit regulations by conducting RPTs through
subsidiaries.

3. Funding Misuse:

o Companies have been found using shareholder funds to invest in promoter groups'
projects, often through quasi-debt mechanisms, instead of safer investments.

4. Vague Disclosures:

o Details of RPTs are often reported under broad categories (e.g., "Associates," "Joint
Ventures") without specific explanations, leading to a lack of transparency and trust
from smaller shareholders.

5. Information Deficiency:

o Small investors are often uninformed about company investments due to vague
disclosures in annual reports, making it difficult to evaluate RPTs.

o Audit Committees frequently fail to disclose RPT risks due to poorly framed statements,
impacting the accuracy of voting outcomes.

Suggestions for Strengthening Corporate Governance

1. Board Responsibility and Approval Processes:

o The Board must be diligent in identifying and approving RPTs. Checks and approvals by
the Audit Committee should be established to safeguard investor interests.

2. Defining “Arm’s Length”:

 o A clear definition of "arm's length" transactions should be formulated under Section 188
of the Act, including parameters to identify unrelated transactions.

3. Material RPT Thresholds:

o The current thresholds for “material” RPTs (10% of annual consolidated turnover) are
considered high, allowing some RPTs to evade approval. A reduction in these thresholds
is necessary.

4. Fixed Reporting Format:

o A standardized reporting format for RPTs should be implemented to ensure

comprehensive disclosures. Companies must explain why certain high-value transactions
are not conducted with unrelated entities, and independent financial advisors should
review these transactions prior to approval. Reports must be included in the annual
report.

MCA Report of the Expert Committee on Company Law

1. Duties of Directors

• Directors have collective authority to manage company affairs but owe individual duties of good
faith and fair dealings.

• Directors must avoid situations where personal interests conflict with fiduciary duties towards
the company.

• Directors should not exploit company assets, opportunities, or information for personal gain.

2. Regulatory Framework for Related Party Transactions

• The Committee discussed whether to regulate transactions involving directors or their relatives
via:

o Government Approval-based regime

o Shareholder Approval and Disclosure-based regime

• The latter was deemed more suitable for India, based on international practices.

3. Director’s Duty to Disclose Interest

• 3.1 Directors must disclose any existing or proposed contracts or arrangements with the
company in which they have an interest.

• 3.2 The Act should specify how, when, and to what extent disclosures should be made. Directors
should notify the Board during meetings where relevant transactions are discussed.

• 3.3 Failure to disclose should be considered a default, leading to penalties and potential
disqualification from office.

• 3.4 Directors’ Responsibility Statements should confirm that all relevant disclosures have been
made.
 • 3.5 Interested directors must abstain from participating in discussions about the transactions
they are involved in.

• 3.6 A register of transactions over a specified threshold involving directors' interests must be
maintained and accessible for member inspection.

4. Approval of Certain Transactions

• 4.1 Transactions related to the sale or purchase of goods/services must have Board approval,
with a threshold limit established.

• 4.2 Shareholder approval by special resolution is required for transactions above this threshold,
with details included in the explanatory statement sent to shareholders.

• 4.3 Similar provisions apply to transactions involving the transfer or lease of immovable property
involving interested directors.

• 4.4 The exemption under Section 297 (2)(a) of the Companies Act for transactions at market
price continues.

• 4.5 Regular disclosures of ordinary transactions with holding/subsidiary companies must be

provided to the Board.

• 4.6 Non-ordinary transactions with related companies require Management justification and
must be reported to the Board and summarized in the Annual Report.

• 4.7 Non-compliance results in penalties on directors, voiding of contracts, requirement to

account for gains, and disqualification from office.

5. Disclosure of Directorships and Shareholdings

• 6.1 Directors must disclose personal information, directorships, shares held, and interests in
other entities.

• 6.2 Non-disclosure holds directors liable for fines.

• 6.3 The company must maintain a register of these details, accessible to all members.

ICICI Bank Case Overview

• In 2008, Chanda Kochhar's husband, Deepak Kochhar, and Venugopal Dhoot of Videocon started
NuPower Renewable Private Limited (NRPL), creating a potential conflict of interest.

• Kochhar sanctioned multiple loans to the Videocon Group while CEO, leading to significant NPAs.

• Allegations arose of a quid pro quo involving loans and ownership transfers, prompting
investigations by the CBI and SEBI.

Timeline of Events

• 2008-2011: Loans to Videocon Group sanctioned by Kochhar.

• 2016: Allegations of misconduct emerge; Kochhar remains in office during inquiries.

 • 2018: Various agencies initiate probes, and an independent committee is formed.

• 2019: CBI files FIRs against Kochhar and others for loan irregularities.

Key Issues Raised

• Questions about corporate governance and failure to act on conflicts of interest.

• Inquiries were conducted externally rather than internally, raising concerns about oversight.

• Kochhar's request for early retirement amid investigations sparked further scrutiny.

Allegations of Quid Pro Quo

• CBI detailed a sequence of loans linked to financial benefits for Kochhar's family through Dhoot.

• Loan Structure: Loans were sanctioned under conditions that benefited NRPL, linked to
Kochhar’s interests.

Legal Considerations

• Related Party Transactions (RPTs) under the Companies Act, 2013:

o Kochhar’s relationship with Dhoot did not meet the legal criteria for RPTs.

o Several sub-clauses in the definition of RPTs did not apply, complicating the legal
implications of her actions.

Conclusion

• The situation illustrates significant failures in corporate governance within ICICI Bank.

• The report suggests a need for stricter regulations and compliance measures regarding related
party transactions and conflicts of interest in companies.

This summary captures the main points and implications from the MCA report and the ICICI Bank case
while highlighting the significant regulatory recommendations and the surrounding legal context.
 Unit 11
Overview of SFIO

• Establishment and Purpose: The SFIO was established in 2003 under the Ministry of Corporate
Affairs in response to various financial frauds and market scams in India. Its primary role is to
investigate and prosecute white-collar crimes, especially those that are complex and involve
multiple disciplines and public interest.

Composition and Structure

• Expertise: The organization consists of a multi-disciplinary team of experts, including those in

accountancy, forensic auditing, law, IT, investigations, company law, capital markets, and
taxation.

• Leadership: The SFIO is headed by a Director at the Joint Secretary level, supported by
Additional Directors, Joint Directors, Deputy Directors, Senior Assistant Directors, and other staff
members.

• Headquarters and Regional Offices: The main office is located in New Delhi, with regional offices
in Mumbai, Chennai, Hyderabad, and Kolkata.

Investigation Process

• Authority and Jurisdiction: The SFIO acts only upon orders from the Union Government,
ensuring that its investigations are robust and focused.

• Powers: It has the authority to arrest individuals involved in fraud, particularly targeting
Directors, Additional Directors, and Assistant Directors.

• Scope of Investigation: The SFIO investigates serious fraud cases referred by the Ministry of
Corporate Affairs (MCA) and examines not only visible frauds but also the equitable treatment of
minority shareholders.

Legal Framework

• Section 210: This section allows the Central Government to investigate a company's affairs based
on reports from the Registrar, special resolutions, or public interest considerations.

• Section 211: Establishes the SFIO and outlines its leadership structure and the appointment of
experts necessary for its functions.

Offences and Penalties

• Types of Fraud: Several offences are highlighted, including:

o Filing incorrect documents with the Registrar of Companies (ROC).

o Fraudulent contracts and misstatements in prospectuses.

o Inducing investments fraudulently and impersonation related to securities.

o Mismanagement and suppression of beneficial ownership information.

 • Consequences: Individuals involved in these fraudulent activities, including promoters and
company officers, may face serious legal repercussions.

Context and Background

• Historical Context: The formation of the SFIO was influenced by stock market scams in the late
1990s and early 2000s, which prompted a need for stronger regulatory oversight.

• Naresh Chandra Committee: This committee recommended the establishment of the SFIO to
enhance corporate governance and tackle white-collar crimes.

The SFIO plays a critical role in safeguarding the interests of investors and the public by ensuring
accountability and transparency in corporate governance. Its interdisciplinary approach allows
for thorough investigations and the potential for systemic improvements in laws and procedures
to prevent future frauds.

4o mini

Overview of Section 212: Investigation into Affairs of Company by SFIO

Authority and Exclusivity of SFIO Investigations

• Exclusive Authority: Once a case is assigned to the SFIO by the Central Government for
investigation under the relevant Act, no other agency (central or state) may conduct an
investigation regarding the same offences. Any ongoing investigations by other agencies must
cease, and relevant documents must be transferred to the SFIO.

Investigation Process

• Assignment and Reporting: The SFIO is tasked with conducting the investigation and must
submit its report to the Central Government within the specified time frame set out in the
assignment order.

• Investigating Officer: The Director of the SFIO will appoint an Investigating Officer who has
powers similar to those of an inspector under Section 21.

• Cooperation Requirement: The company and its officers/employees are obligated to provide all
necessary information, explanations, documents, and assistance to the Investigating Officer for a
thorough investigation.

Arrest Provisions

• Cognizability of Offences: Offences under Section 447 are cognizable, meaning that arrests can
be made without a warrant. An accused person cannot be released on bail unless:

1. The Public Prosecutor has the opportunity to oppose the bail application.
 2. If opposed, the court must find reasonable grounds for believing the accused is not
guilty and unlikely to commit further offences on bail.

• Special Considerations for Bail: Certain individuals, such as those under 16, women, or those
who are sick or infirm, may be released on bail at the discretion of the Special Court.

• Authorization for Arrest: An officer not below the rank of Assistant Director may arrest an
individual if there are reasonable grounds to believe the person has committed an offence,
documenting the reasons for such belief in writing.

• Immediate Procedure Post-Arrest: After an arrest, the officer must promptly inform the arrested
individual of the grounds for their arrest and send a copy of the order along with supporting
materials to the SFIO in a sealed envelope.

Judicial Procedure

• Initial Court Appearance: Every arrested individual must be presented before a Special Court or
Judicial Magistrate within 24 hours of the arrest.

• Interim Report: The SFIO is required to submit an interim report detailing the reasons for the
arrest, including information on questioning and investigation.

• Final Investigation Report: Upon completing the investigation, a comprehensive report is

submitted to the Central Government.

Prosecution and Further Actions

• Prosecution Direction: Following the review of the investigation report, the Central Government
may instruct the SFIO to initiate prosecution against the company and its relevant
officers/employees.

• Disgorgement of Benefits: If fraud is confirmed and any individuals or entities benefited unduly,
the Central Government may file an application with the Tribunal for orders to recover such
benefits and hold those responsible personally liable without limitations.

• Report as Police Report: The investigation report submitted to the Special Court for framing
charges is treated as a police report under Section 173 of the Code of Criminal Procedure, 1973.

Information Sharing

• Inter-Agency Cooperation: If the SFIO is conducting an investigation, other agencies, including

state governments, police authorities, and income tax authorities, must provide any relevant
information or documents they possess.

• Reciprocal Information Sharing: The SFIO is also obligated to share pertinent information or
documents with other investigating bodies that could assist in their inquiries.

Conclusion

Section 212 establishes a robust framework for the investigation of corporate frauds by the SFIO,
ensuring that investigations are conducted with exclusivity, thoroughness, and adherence to legal
protocols. The provisions for arrest, cooperation from companies, and inter-agency collaboration
highlight the seriousness with which white-collar crimes are treated under the law.

Section 217: Procedure, Powers, etc., of Inspectors

Duties of Officers and Employees

• Obligation to Assist: All officers, employees, and agents of a company under investigation must:

o Preserve and Produce Documents: Provide all books, papers, and documents related to
the company or relevant individuals that are in their custody or control to the inspector
or authorized personnel.

o Provide Assistance: Offer reasonable assistance to the inspector during the

investigation.

Custody and Examination

• Custody Duration: Inspectors can retain documents and materials for a maximum of 180 days,
after which they must be returned.

• Examination of Individuals: Inspectors may examine any person or officer relevant to the
investigation, but only with prior approval from the Director of the SFIO.

Powers of Inspectors

Inspectors possess powers equivalent to those of a civil court, which include:

• Discovery and Production: Authority to demand the discovery and production of documents at
specified places and times.

• Summoning and Examining: Ability to summon individuals and examine them under oath.

• Inspection of Records: Right to inspect books, registers, and documents of the company at any
location.

Penalties for Non-compliance

• Disobedience to Directions: If a director or officer disobeys directions from the Registrar or

inspector, they face:

o Imprisonment: Up to one year.

o Fines: Between ₹25,000 and ₹100,000.

• Vacating Office: A director or officer convicted of an offence automatically vacates their position
and is disqualified from holding any office in a company.

Examination Notes

• Written Records: Notes from any examination must be documented, read over, and signed by
the person examined, which may be used as evidence against them.
Failure to Cooperate

• Refusal to Cooperate: Any individual who fails or refuses to cooperate with an inspector without
reasonable cause may face:

o Imprisonment: Up to six months.

o Fines: Between ₹25,000 and ₹100,000, with additional fines of up to ₹2,000 for each day
of continued non-compliance.

Assistance from Government Authorities

• Support from Officials: Central Government, State Government, police, or statutory authorities
must assist inspectors in inspections and investigations, upon the inspector's request and with
prior approval from the Central Government.

• International Cooperation: The Central Government may enter agreements with foreign states
for mutual assistance in inspections and investigations.

Section 218: Protection of Employees During Investigation

Approval Requirement for Employment Actions

During an investigation or proceedings against individuals involved in a company’s management, the

following actions require Tribunal approval:

1. Discharge or Suspension: Proposing to discharge or suspend any employee.

2. Punitive Actions: Proposing to punish an employee (e.g., dismissal, removal, or demotion).

3. Change of Employment Terms: Proposing to alter an employee's terms of employment

detrimentally.

Tribunal Approval Process

• Request for Approval: The company or relevant body must seek Tribunal approval before taking
any employment action.

• Notification of Objection: If the Tribunal objects to the proposed action, it must send written
notice to the concerned company or body.

• Timeframe for Action: If the company does not receive Tribunal approval within 30 days of the
application, it may proceed with the proposed action.

Appeal Against Tribunal Objection

• Right to Appeal: If the company is dissatisfied with the Tribunal’s objection, it may appeal to the
Appellate Tribunal within 30 days of receiving the objection notice.

• Finality of Appellate Tribunal Decision: The decision of the Appellate Tribunal is final and
binding on both the Tribunal and the company or body concerned.
Conclusion

Sections 217 and 218 outline the comprehensive powers and procedures for inspectors conducting
investigations into corporate affairs while also providing protection for employees against arbitrary
actions during such investigations. The stipulations ensure cooperation from company personnel and
safeguard employee rights throughout the investigative process.

4o mini
Unit 12
Shareholder Activism

Definition:

• Shareholder activism refers to the efforts by shareholders to influence the management and
operations of a company to achieve desired changes and protect shareholder interests.

Legal Framework

1. Companies Act 2013:

o This is the primary source of law governing shareholder activism in India.

2. Securities and Exchange Board of India (SEBI) Regulations:

o Regulations formulated by SEBI provide additional rights and remedies to shareholders

of listed companies.

Shareholder Rights and Actions

• Approval Requirements:

o Shareholders' approval is necessary for specific transactions and decisions within the
company.

• Legal Actions:

o Shareholders can initiate a class action suit against the company, its directors, and third-
party advisers.

o They have the right to sue for oppression and mismanagement and can exit under
specified circumstances.

SEBI Regulations

• Stakeholders' Relationship Committee:

o Listed companies are required to form a Stakeholders' Relationship Committee to

address shareholder grievances.

• Electronic Voting:

o Companies must provide electronic voting facilities to enhance shareholder participation

in decision-making.

Proxy Advisory Firms (PAFs)

• Role and Influence:

o PAFs, regulated by SEBI under the Research Analysts Regulations, play a significant role
in shareholder activism.
 o They advise institutional investors and shareholders on exercising their rights, including
voting recommendations and public offers.

o Recommendations from PAFs significantly influence voting patterns among shareholders.

• Examples of PAFs:

o Egan-Jones Proxy Services (USA)

o Glass, Lewis & Co (USA)

o Institutional Shareholder Services (USA)

o Minerva Analytics Ltd (India)

o Institutional Investor Advisory Services India Limited (IiAS) (India)

o Stakeholders Empowerment Services (SES) (India)

o GIR Inc. (Canada)

Objectives of Shareholder Activism

1. Break up and sell parts of the business.

2. Issue generous dividends to shareholders.

3. Simplify the corporate structure through divestitures.

4. Conduct asset sales to fund share repurchases and debt repayment.

5. Disclose climate change risks voluntarily.

6. Sell prior acquisitions and separate operations (e.g., design and manufacturing).

7. Revamp human resource policies.

8. Implement disciplined capital allocation practices.

9. Adjust the number of directors as needed.

10. Increase the number of independent directors on the board.

11. Overhaul management compensation structures.

12. Establish better internal control mechanisms.

13. Change or replace management when necessary.

Tools Available to Activist Shareholders

• Rights of Shareholders:

o Right to receive information about the company's affairs.

o Right to give approval for certain corporate actions.

 o Right to appoint and remove directors.

o Right to appoint an auditor.

o Right to requisition a meeting of shareholders.

• Electronic Voting:

o Available for listed companies or those with more than 1,000 shareholders.

• Grievance Redressal Mechanisms:

o Listed companies or those with more than 1,000 security holders must establish a
Stakeholders' Relationship Committee.

o Registration on the SCORES platform (operated by SEBI) is mandatory for listed

companies to facilitate grievance resolution.

• Oppression and Mismanagement Proceedings:

o At least 100 members or 10% of the total membership (whichever is less) or

shareholders holding at least 10% of issued share capital can approach the National
Company Law Tribunal (NCLT) to initiate proceedings for oppression or mismanagement.

• Class Action Suits:

o Shareholders can file class action suits to collectively seek remedies against the company
or its management.

• Application to the Serious Fraud Investigation Office (SFIO):

o Shareholders can approach the SFIO regarding serious corporate misconduct or fraud.

Conclusion

Shareholder activism plays a crucial role in promoting corporate governance and accountability, enabling
shareholders to influence management decisions and protect their interests effectively. The legal
frameworks established by the Companies Act 2013 and SEBI regulations empower shareholders to take
collective action when necessary, enhancing their rights within the corporate structure.

Rights of Shareholders in India

1. Right to receive information - Shareholders are entitled to receive information and documents such as:

• annual return extracts;

• audited financial statements along with an auditor's report; and

• statutory registers maintained by the company (such as the register of members, debenture-
holders, directors and key managerial personnel).
2. Right to give approval - A company is managed by the board, but the Companies Act 2013 restricts the
powers of the board to an extent and certain important matters require the consent of the shareholders.
Their approval can be obtained either by a simple majority or special majority, as prescribed under the
Companies Act 2013. These include amending the company's memorandum of association or articles of
association, appointing and removing directors, and obtaining loans and sale of undertakings above
certain thresholds. Shareholders have used this voting right as a tool to defeat resolutions they want to
oppose. The requirement of shareholder approval ensures active shareholder involvement in matters
that are critical to the company. In public companies, shareholder approval is required by a special
majority for matters or transactions, including:

• sale or lease of a company's whole or substantially whole undertakings;

• investment of compensation received as a result of any merger or amalgamation; and

• entering into related party transactions (RPT) over a certain threshold.

3. Right to appoint and remove directors - The directors of a company are appointed by its shareholders.
Independent directors appointed by listed companies and specific public companies are required to be
approved by shareholders in a general meeting before they are appointed. In addition, small
shareholders holding shares of not more than INR 20,000 in value can propose the appointment of a
director on the board of a listed company subject to certain terms and conditions. This way small
shareholders can seek board representation.

4. Right to appoint auditor - The auditor is appointed by the shareholders in an annual general meeting
at the recommendation of the board or the audit committee. This appointment is for a five-year period

5. Right to requisition a meeting - Shareholders can requisition the directors to convene an extraordinary
general meeting for consideration of company matters and for voicing their opinion. If the directors fail
to convene an extraordinary general meeting, the requisitionist shareholders can call a meeting on their
own. The minimum threshold for calling such a meeting is 10% of the shareholders with voting rights in
the company.

6. Right to electronic voting - Shareholders can benefit from the electronic voting facility as every listed
company or a company having at least 1,000 members must have an electronic voting facility at general
meetings. Electronic voting has increased shareholder participation and eased the process of voting.

Remedies available to Shareholders under Companies Act 2013-

a. Grievance redressal mechanisms - A listed company or a company with more than 1,000
shareholders, debenture holders, deposit holders and any other security holders at any time
during a financial year must have a Stakeholders Relationship Committee to resolve security
holder grievances. Listed companies must also be registered on the SCORES platform (operated
by the Securities and Exchange Board of India). SCORES enables investors to file complaints and
track the status or redressal of these complaints. This is an example of the shareholders' right
to have their grievances and concerns heard.
 b. Oppression and mismanagement proceedings - A minimum of 100 or 10% of the total number of
members (whichever is less), or any member or members holding at least 10% of the issued
share capital of the company, can approach the Tribunal to initiate proceedings for oppression
and/or mismanagement on the ground that the company's affairs are being conducted in a
manner prejudicial to the interest of the company or its members

c. Class action suits - If the rights of any of the members are infringed or the conduct of the
management is prejudicial to the interest of the company or its shareholders, the following can
bring a class action suit against the company, its directors and third-party advisers:

• a minimum of 100 members or at least 5% of the total number of members (whichever is less);
or

• any member or members holding at least 5% of the issued share capital in an unlisted company
or at least 2% of the issued share capital in a listed company.

d. Derivative actions - A single shareholder, irrespective of his/her shareholding in the company, can also
bring a derivative suit on behalf of the company challenging a board resolution if it was detrimental to
the interest of the company. However, the shareholder must approach the court with "clean hands". The
derivative action procedure is set out in the Code of Civil Procedure 1908

e. Application to the Serious Fraud Investigation Office (SFIO) - The shareholders by passing a special
resolution can intimate to the Central Government that the affairs of the company are required to be
investigated. The Central Government, on receiving such a request, can order the SFIO to investigate the
affairs of the company.

Minority Rights & Corporate Governance - Balance to be struck between the rule of the majority and
the rights of the minority

1. The fundamental principle defining operation of shareholders democracy is that the rule of
majority shall prevail.

- it is also necessary to ensure that this power of the majority is placed within reasonable bounds
and does not result in oppression of the minority and mis-management of the company.

- The minority interests, therefore, have to be given a voice to make their opinions known at the
decision making levels. The law should provide for such a mechanism.

- in cases where minority has been unfairly treated in violation of the law, the avenue to approach
an appropriate body for protecting their interests and those of the company should be provided
for.

- The law must balance the need for effective decision making on corporate matters on the basis
of consensus without permitting persons in control of the company, i.e., the majority, to stifle
action for redressal arising out of their own wrong doing.

2. concept of independent directors would provide an objective scrutiny of management, operations and
decision making, the Boards of the companies could also incorporate the concept of representation of
specific minority shareholders group. The specific minority appointed director/independent director
could also play an important role in investor protection. The Committee view was that the existing
option may be retained

3. The risks of investors can be reduced / minimized through adequate transparency and disclosures.
The law should indicate in clear terms the rights of members of the company to get all information to
which they are entitled in a timely manner.

4. Right of minority to be heard - Once the principle of protection of “Minority Interest” is recognized in
the Act, there would also be a need to put in place an appropriate mechanism for ensuring that such
provisions relating to “Minority Interest” do not obstruct the Board or the management from performing
their functions genuinely in interests of the company. The Board and the management should, therefore,
be protected from undue and unjustified interference from unscrupulous shareholders acting in the
guise of investors’ rights.

5. Rights of minority shareholders during meetings of the company - The procedures to be prescribed
under the Act should safeguard against such behaviour by the company. There should be extensive use
of postal ballot including electronic media to enable shareholders to participate in meetings.

6. Rights in case of Oppression and Mismanagement - Minority, represented by specified number of

members or members holding requisite percentage of equity capital are entitled to approach
Courts/Tribunals for protection of their interests. The quasi-judicial body is empowered to order a
number of remedial measures for regulation of the conduct of company’s affairs. These measures, inter-
alia, include purchase of shares or interests of any members of company by other members;
termination, setting aside or modification of agreements relating to managerial personnel; setting aside
of transactions relating to transfer, delivery of goods etc, or any other matter for which Court/Tribunal
feels that provisions should be made. The Court/Tribunal is also empowered to appoint such number of
persons as necessary to effectively safeguard interest of the company.

7. Rights of minority shareholders during mergers/ amalgamations/ takeovers –

- As per existing provisions of the Act, approval of High Court / Tribunal is required in case of
corporate restructuring (which, inter-alia, includes, mergers/amalgamations etc.) by a company.

- The Scheme is also required to be approved by shareholders.

- Though there may not be any protection to any dissenting minority shareholders on this issue,
the Courts, while approving the scheme, follow judicious approach by mandating publicity about
the proposed scheme in newspaper to seek objections, if any, against the scheme from the
shareholders. Any interested person (including a minority shareholder) may appear before the
Court.

8. Fair valuation as a means of safeguarding minority interests - principle of valuation of shares of a

company through an independent valuation mechanism as means of safeguarding minority interests.

- The independent valuer should be appointed by Audit Committee

- The shareholders should have the right to approach the Court / Tribunal if they perceive the
process to be unfair.
Small Shareholders Director - Section 151

Definition of Small Shareholders:

• A "small shareholder" is defined as a shareholder holding shares with a nominal value not
exceeding twenty thousand rupees or any other sum as prescribed by regulations.

Eligibility for Small Shareholders Director (SSD):

• Only listed companies can opt to have a Small Shareholders Director under Section 151 of the
Companies Act.

Nomination Process:

• Under Rule 7 of the Companies (Appointment and Qualification of Directors) Rules, 2014:

o A minimum of 1,000 small shareholders or one-tenth of the total number of

shareholders of a listed company may recommend the election of an SSD.

o Small shareholders intending to propose a candidate for SSD must notify the company at
least 14 days prior to the general meeting. The notice should include:

▪ Name and address of the proposed candidate.

▪ The number of shares held by the candidate.

▪ Names of the small shareholders proposing the candidate.

Appointment Process:

• A small shareholder director can be appointed either at the company’s initiative or in response
to a request from small shareholders.

• A small shareholder director cannot hold the position of a Whole-Time Director or Managing
Director.

Notice Requirements:

• A notice must be provided at least 14 days before the general meeting if small shareholders wish
to designate an SSD.

• The notice must include:

o The name, address, and number of shares held by the proposed SSD candidate.

o A statement with the following declarations:

▪ Director Identification Number (DIN) of the prospective candidate.

▪ Confirmation that the candidate is not ineligible to serve as a director.

▪ Permission from the candidate to act as a director.

Resolution and Voting:

 • After fulfilling the notice requirements, a resolution for the appointment of the SSD must be
passed at the general meeting.

• The election of the small shareholder nominee is conducted via postal ballot.

Proxy Advisory Firms and Their Role in Indian Corporate Governance

Definition:

• Proxy advisory firms are organizations or individuals that provide recommendations and advice
to institutional investors and shareholders, aiding them in casting votes on policy issues or public
offers.

Function and Importance:

• These firms are independent entities that analyze corporate decisions, weigh pros and cons, and
provide research-based voting recommendations.

• While directors typically manage day-to-day issues, shareholders, as the actual owners of the
company, also vote on significant matters affecting the company.

Challenges for Shareholders:

• Many shareholders prioritize profits (e.g., dividends) and may not be well-informed about
corporate policies, issues, or notices, creating a need for independent analysis.

• Proxy advisory firms assist these shareholders by evaluating decisions and providing informed
recommendations on matters such as executive compensation and corporate governance.

Role in Shareholder Activism:

• Proxy advisory firms play a crucial role in shareholder activism and corporate governance.

• They provide research-based recommendations on various issues that require shareholder

approval, including:

o Election of board directors.

o Approval of equity-based compensation programs.

o Advisory approval of management compensation.

o Acceptance of deposits and management or shareholder-sponsored initiatives related to

governance policies.

Voting Influence:

• Decisions on whether to vote for or against various resolutions during annual general meetings
are increasingly influenced by proxy advisors’ recommendations.

• Voting is primarily conducted by custodians on behalf of institutional investors based on these

recommendations.

Home-Grown Proxy Advisory Firms:

 • India has several domestic proxy advisory firms, including:

o Institutional Investor Advisory Services (IiAS).

o In Govern.

o Stakeholder Empowerment Services (SES).

Increasing Shareholder Involvement:

• Shareholders are becoming more active in governance-related decisions and are making
informed voting choices based on analyses provided by proxy advisory firms.

• Institutional investors, who may not be able to track policies and performance across multiple
companies, increasingly rely on the services of proxy advisory firms to stay informed.

Conclusion

The introduction of Small Shareholders Directors under Section 151 encourages the participation of
small shareholders in corporate governance, allowing their voices to be heard within the decision-
making processes of listed companies. Meanwhile, proxy advisory firms enhance this landscape by
providing essential research and recommendations, helping shareholders navigate complex corporate
issues and contribute effectively to governance. Together, these mechanisms promote greater
accountability and transparency in corporate practices.

Functions of Proxy Advisory Firms

1. Advisory Services:

o Provide guidance on intricate matters relating to corporate governance and company

operations.

2. Voting Rights Assistance:

o Aid shareholders in exercising their voting rights on significant corporate decisions, such
as:

▪ Appointment of directors.

▪ Changes in company policies.

3. Corporate Governance Reports:

o Prepare reports that serve as scorecards or ratings on the corporate governance

practices of entities, evaluating their governance standards.

4. Environmental, Social, and Governance (ESG) Analysis:

o Conduct ESG analysis to evaluate a company's performance across environmental, social,

and governance factors, identifying growth opportunities and potential threats. This
analysis helps both the company and its shareholders to strategize effectively.

5. Risk Monitoring:
 o Monitor risks associated with the company’s operations and protect the interests of
investors by providing insights into potential issues.

6. Regulatory Compliance:

o Proxy advisory firms operating in India are required to:

▪ Obtain a license under SEBI (Securities and Exchange Board of India)

Regulations.

▪ Adopt a code of conduct as prescribed by SEBI Regulations.

7. Internal Policies and Conflict of Interest Management:

o Regulation 15 (1) of SEBI Regulations mandates that entities maintain internal policies
governing the dealings and trading by research analysts to address actual or potential
conflicts of interest arising from such activities.

8. Compensation Review:

o Regulation 17 stipulates conditions for the compensation of research analysts, requiring

that their compensation be reviewed by the board of the research entity and be
independent of the brokerage services division.

9. Report Distribution Restrictions:

o SEBI Regulations restrict the publication and distribution of reports concerning any
subject company where the research analyst has acted as a manager or co-manager.

10. Conflict of Interest Disclosures:

o According to SEBI's procedural guidelines for proxy advisors (issued on August 3, 2020):

▪ Proxy advisors must disclose conflicts of interest in all advisory documents.

▪ Disclosures should specifically address potential conflicts and the safeguards

established to mitigate them.

11. Clear Procedures for Conflict Management:

o Proxy advisory firms are required to establish clear procedures for disclosing, managing,
and mitigating any potential conflicts of interest that may arise from other business
activities, including consulting services, and must disclose this to clients.

Prevention of Shareholder Activism (Company’s Perspective)

1. Concentration of Shareholding:

o Substantial increases in shareholding by a few shareholders can lead to concentrated

control over the company, which may trigger activism.

2. Director Duties:
 o Directors failing to fulfill their obligations under the Companies Act, 2013, may incite
dissatisfaction among shareholders.

3. Financial Controversies:

o Controversial financial transactions or ethically questionable behavior by board

members can erode shareholder trust and lead to activism.

4. Management Instability:

o Frequent changes in management can lead to instability, making it difficult to address

shareholder concerns or to formulate coherent strategies.

5. Communication Gaps:

o A lack of communication with shareholders can lead to misunderstandings and

discontent, fostering an environment ripe for activism.

6. Ignoring Shareholder Concerns:

o Disregarding shareholder concerns regarding significant company dealings can escalate

dissatisfaction and activism among shareholders.

7. Management Responsiveness:

o Inability or unwillingness of management to resolve shareholder issues can prompt

increased activism.

8. Poor Financial Performance:

o Weak financial performance, especially in comparison to industry peers, can trigger

activism as shareholders demand accountability.

9. Disclosure of Beneficial Ownership:

o Certain declarations concerning the beneficial ownership of shares must be disclosed by

the relevant shareholder and beneficial owner to the company, ensuring transparency
and compliance.

Conclusion

Proxy advisory firms play a crucial role in enhancing corporate governance by providing essential
advisory services and facilitating informed shareholder participation in key decisions. Meanwhile,
companies can take proactive steps to prevent shareholder activism by fostering transparent
communication, ensuring ethical management practices, and addressing shareholder concerns promptly.
By maintaining good governance practices and engaging with shareholders, companies can mitigate the
risks associated with shareholder activism.
Minimising the Risk of Being Targeted by the Company - Shareholder activists usually target companies
when a weakness is detected in the management or financial dealings of the company. The practical
steps that a company can take to minimise the risk of being targeted by activist shareholders include
the following:

• The board needs to balance its role between legislative compliance, corporate strategy and
policy-making. Clarity on the role of the board and its members helps maintain a good relation
between the management and shareholders, which builds shareholder confidence.

• The board must regularly assess its own performance and that of individual directors, and it
should consider addressing any issues that are discovered. A clean governance record can help
minimise shareholder activism.

• Monitoring the shareholder base to identify the top 20-25 shareholders so that the
management can anticipate and understand their attitude and potential concerns, and deal
with them effectively.

• Maintaining a good relationship with shareholders through effective outreach and

communication.

• Invite shareholder comments on periodic updates on the matters concerning the company
finances and long-term targets.

• Have a long-term strategic plan and articulate its benefits.

• Make detailed facts and reasons available to the shareholders regarding major company
dealings.

• Resolve shareholders' issues directly and in a timely fashion.

• Regularly assess the valuation, performance and policies of the company.

• Clauses that can be added to the articles of association that minimise the risk of being
targeted by activist shareholders include:

• Clearly incorporating contractual rights in the articles of association of the company.

• Incorporating corporate governance norms that are not required by law in the articles of
association to raise shareholder confidence in the company.

Steps the Company can take when faced with Shareholder Activism -

Responding Before a General Meeting

• Proactively and directly dealing with the concerns of the shareholder activist.

• Assuring the shareholder activist that the issues raised will be considered seriously by the
management.

• Objectively considering the ideas of the shareholder activist.

 • Evaluating and communicating the risk factors relating to the proposal of the shareholder
activist.

• Formulating an arrangement that is aligned to the interest of the shareholders and concerns of
the company.

Responding at a General Meeting

• Elaborating on the proposed strategy to be implemented.

• Convincing the shareholder activists why the proposed strategy is in the best long-term interests
of the company and its members.

Responding after a General Meeting

• Continuous review of the governance policies of the company and the strategy implemented.

• Engaging in interactive dialogues with the shareholders concerned.

Shareholder Activism – USA

- Shareholder activism is and will continue to be a prominent feature of the corporate landscape
in the United States. Following a wave of corporate scandals in the early 2000s (most
memorably Enron Corporation), there was a sea change in US corporate governance.
Subsequently enacted federal regulations that focus on corporate governance have dramatically
changed the face of US corporate boards of directors; shareholder engagement has become an
expectation for companies; and a number of other legal and cultural changes have increased the
power of shareholders of US public companies

- The legal and regulatory framework relating to shareholder rights, activism and engagement in
respect of US publicly traded companies primarily comprises

i. federal laws and regulations

ii. state corporations laws.

- US public companies also must comply with the listing rules of their stock exchange (either the
New York Stock Exchange or the Nasdaq Stock Market), which include corporate governance
requirements.

- Additional sources of practice with respect to shareholder activism and engagement include
proxy advisory firms and guidelines set forth by other investment community members.

- Taken together, the applicable laws and regulations, as well as other influential sources of
practice, govern the means by which a shareholder activist pursues an activist campaign and the
structural defences against shareholder activists available to US public companies.

(Suggested Reading - https://thelawreviews.co.uk/title/the-shareholder-rights-and-activism-

review/usa#:~:text=Shareholder%20activists%20pursue%20a%20variety,share%20repurchases%2C%20o
perational%20and%20capital)

Federal laws
 - Federal securities laws relating to shareholder activism and engagement include the Securities
Act of 1933, the Securities Exchange Act of 1934 (the Exchange Act), the Sarbanes-Oxley Act of
2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-
Frank Act).

- The federal securities laws, and the rules and regulations promulgated thereunder, are
administered by the Securities and Exchange Commission (SEC).

- A key focus of the federal securities regulations is on disclosure and ensuring that shareholders
and the market have the information required to make fully informed investment decisions

State laws

- State corporations law governs actions by companies in the state's jurisdiction and establishes
the fiduciary duty regime that applies to a company's directors and officers.

- state of Delaware is the most popular state of formation for legal entities and its laws
significantly influence corporate law in other states.

- Many provisions of the Delaware General Corporation Law (DGCL) govern the relationship
between a corporation and its shareholders, impacting the processes by which a shareholder
activist may pursue, and a company may defend against, an activist campaign

- The DGCL includes laws governing, among other things, the composition of the corporation's
board of directors, annual and special meetings of shareholders, actions by written consent,
voting thresholds for approving corporate actions, requests by shareholders for books and
records, and appraisal rights.

- Shareholder activism and engagement are influenced by other sources of practice and various
members of the investment community. Although their impact has waned somewhat in recent
years, proxy advisory firms such as Institutional Shareholder Services (ISS) and, to a lesser
extent, Glass Lewis have an impact on a company's corporate governance policies and may
affect the outcome of a proxy contest with a shareholder activist.

- These advisory firms set forth policy guidelines as well as make recommendations with respect
to proposals to be voted upon at a shareholders' meeting, such as director elections,
fundamental transactions and other governance matters.

Shareholder activists primarily fall into two categories in the US

1. hedge fund activists - Hedge fund activists are investors whose investment strategy is to identify
what they consider to be vulnerabilities at certain companies and purchase a sizeable minority
stake in those target companies with the view that changes they recommend and agitate for, if
successful, will increase shareholder value and result in a financial gain for their investment
portfolio

2. Rule 14a-8 activists - are shareholders that submit proposals to companies under Rule 14a-8
promulgated under the Exchange Act, a rule that requires a public company to include a
shareholder proposal in its proxy materials for a shareholders' meeting if certain requirements
 are met by the shareholder. A company's preparation for and response to activism will differ
depending on the type of shareholder activist it faces.

Shareholder Activism - United Kingdom

The Companies Act 2006 (the Companies Act or the Act) provides numerous tools that empower
shareholders to make their views known and to drive particular courses of action.

Such methods are rarely used in isolation, but are very often combined with other, non-legal strategies
of engagement, such as engaging with the board (whether privately or through public channels),
conducting a press campaign and eliciting the views of other shareholders

- Section 319A of the Companies Act provides that a traded company must cause to be
answered any shareholders' questions relating to the business being dealt with at the
meeting.

- Members holding 5 per cent of paid up share capital may, pursuant to Sections 303–306 of the
Act, requisition a general meeting and put forward the text of a proposed resolution

- Under Sections 338–340 of the Act, members of public companies who hold 5 per cent (or at
least 100 members who have a right to vote and hold shares on which an average of at least
£100 per member is paid up) can require resolutions to be put before an annual general
meeting

- Sections 314–317 of the Act, require the circulation of a statement of up to 1,000 words
regarding a matter to be dealt with at a general meeting and can, under Section 527 of the Act,
require the company to publish a statement on its website about audit matters

- Section 979 of the Act, block the squeeze-out of minority holdings following a takeover offer
and those holding more than 25 per cent can block a special resolution in a general meeting, as
well as being able to block an attempted takeover by way of scheme of arrangement

- Section 994 of the Companies Act provides for a shareholder of a company to petition for relief
against unfair prejudice, where the affairs of the company are being conducted in a manner
that is unfairly prejudicial to the interests of members generally

- a shareholder may also bring a derivative claim against the directors of a company under
Section 260 of the Companies Act

- Section 90 of the Financial Services and Markets Act 2000 (FSMA), which grants shareholders
who have suffered loss because of untrue or misleading statements or omissions in a
prospectus a right to be compensated, regardless of the shareholder's ability to show reliance
on the prospectus in question

- Section 90A FSMA, which creates a similar, but less claimant-friendly, regime for other market
announcements (requiring the claimant to be able to show reliance).

(Suggested reading - https://thelawreviews.co.uk/title/the-shareholder-rights-and-activism-

review/united-
kingdom#:~:text=The%20annual%20general%20meeting%20of,can%20deploy%20to%20good%20effect.
)

Unit 13

Chapter 10 Of SEBI (ICDR Regulations)

Innovators Growth Platform (IGP)

Overview

• Purpose: The Innovators Growth Platform serves as a credible and regulated platform for young,
fast-growing companies to list their businesses. It aims to enhance visibility and increase brand
presence for these companies.

Applicability

• Target Companies: The IGP is specifically applicable to companies that make intensive use of:

o Technology

o Information Technology

o Intellectual Property

o Data Analytics

o Biotechnology

o Nanotechnology

• Business Model Focus: The platform is tailored for companies whose business models are
revenue-focused rather than profit-focused, recognizing their unique needs compared to
traditional businesses.

Context and Need

• Growth of the Indian Start-up Ecosystem: In recent years, India has witnessed significant growth
in its startup ecosystem due to:

o Massive funding influx

o Consolidation activities
 o Evolving technology landscapes

o A growing domestic market

• Opportunities for Entrepreneurs: There is a need for startups to connect with potential investors
and raise funds to support their growth trajectories.

• Innovation and Talent Attraction: New-age companies utilizing internet technology and
knowledge-based ideas have attracted top talent, leading to:

o Creation of new job opportunities

o Increased efficiency in the services industry

Benefits of the Innovators Growth Platform

• For Startups:

o Easier listing norms designed to attract a new generation of entrepreneurs.

o Opportunity for local listings to expand the listed universe of startups in India.

• For Investors:

o Access to a large untapped pool of investors seeking new asset classes.

o Ability to channel funds towards a burgeoning entrepreneurial ecosystem.

o New investment avenues for investors looking to diversify their portfolios.

o Opportunities for sophisticated investors to find new exit routes and manage their
portfolios more effectively.

o Local listings provide Indian investors, willing to take on higher risks, the chance to
participate in the growth of startups.

Historical Context

• Initial Efforts: In 2015, SEBI (Securities and Exchange Board of India) established a segment for
listing companies, known as the Institutional Trading Platform (ITP), aimed at attracting startup
listings. However, this initiative did not yield significant results.

• Revised Initiative: In 2018, SEBI reviewed the ITP and made modifications, launching the new
Innovators Growth Platform (IGP) as a more effective version.
Regulatory Framework

• Amendments: SEBI amended the SEBI (Issue of Capital and Disclosure Requirements)
Regulation, 2018 to change the framework of the ITP, facilitating the establishment of the IGP.

Conclusion

The Innovators Growth Platform is a strategic initiative aimed at fostering the growth of India's startup
ecosystem by providing a supportive environment for listing and funding. It addresses the unique
challenges faced by tech-centric and innovative companies, while simultaneously offering new
investment opportunities for investors looking to diversify their portfolios in a burgeoning market.

EBI Amendments to the Innovators Growth Platform (IGP) Listing Norms

1. Listing Eligibility Reduced to One Year

o Previous Requirement: Companies seeking mainboard listing had to demonstrate a

three-year operational history, including profits, assets, and net worth.

o New Requirement: Under IGP, eligible investors are now required to hold only 25% of
the pre-issue paid-up capital for one year instead of two.

o Impact: This change makes it more attractive for companies to list in India.

2. Open Offer Requirement Increased to 25%

o Previous Rule: Under the takeover code (Substantial Acquisition of Shares and Takeover
Regulations, 2011), acquiring 25% or more shares/voting rights in a listed company
necessitated a public announcement of an open offer.

o New Rule: SEBI has increased this threshold to 49% for companies listed on IGP.

o Impact: This change provides startups with more flexibility to raise capital without the
burden of the costly and time-consuming open offer process.

3. Relaxed Mandatory Disclosures

o Previous Requirement: Mainboard companies had to disclose mandatory information

upon acquiring 5% or more shares/voting rights and for any changes of 2%.

o New Requirement: For IGP-listed startups, the threshold for mandatory disclosure has
been increased to 10%, with fluctuations now considered in 5% increments.

o Impact: This change offers startups greater flexibility in disclosure, accommodating their
smaller issue sizes.
4. Delisting Procedure Eased

o Approval:

▪ Mainboard Requirement: A two-thirds majority of shareholders was required

for delisting.

▪ IGP Requirement: Only a majority of minority shareholders is needed for

delisting.

o Acquisition Cap:

▪ Mainboard Requirement: Requires acquiring 90% of shareholding/voting rights

for delisting.

▪ IGP Requirement: Only 75% of shareholding/voting rights are needed.

o Price:

▪ Mainboard Requirement: Pricing must be determined through a reverse book-

building process.

▪ IGP Requirement: The acquirer can propose a price with due justification.

o Impact: These changes simplify the delisting process for startups on IGP.

5. Migration Requirements Down to 50%

o Previous Requirement: Startups wishing to migrate from IGP to the mainboard needed
75% of their capital held by Qualified Institutional Buyers (QIBs).

o New Requirement: This requirement has been reduced to 50%.

o Impact: This makes migration to the mainboard more accessible for IGP-listed
companies.

6. Provision for Differential Voting Rights (DVR) Allowed

o Previous Situation: Companies on the mainboard could issue shares with DVR or
superior voting rights.

o New Provision: Companies listed on IGP are now also allowed to issue shares with DVR
for promoters.

o Impact: This provides startups with additional flexibility in capital structure.

 7. Anchor Investors

o Mainboard Requirement: Companies could transfer up to 60% of the QIB portion of

issued shares to any anchor investor, locked for 30 days from the allotment date.

o IGP Requirement: Companies have full discretion to transfer 60% of any institutional or
non-institutional buyer's portion of issued shares before the issue opening, also subject
to a 30-day lock.

o Impact: This provides greater flexibility in allocating shares to investors.

8. Investor’s Rights to Continue

o Mainboard Situation: Special rights enjoyed by investors typically did not continue after
listing.

o IGP Provision: Investors holding more than 10% of capital before listing can retain
special rights, such as affirmative rights or board rights, even post-listing.

o Impact: This encourages investor confidence and involvement in IGP-listed companies.

9. Lock-In Period Reduced to One Year

o Mainboard Requirement: Post-issue lock-in requirements for Category II Alternative

Investment Funds (AIFs) were not applicable beyond one year.

o IGP Requirement: The lock-in period for IGP listings has been reduced from two years to
one year.

o Impact: This change enhances liquidity for investors in IGP-listed companies.

10. Accredited Investors

o Mainboard Status: The concept of accredited investors did not exist.

o IGP Introduction: SEBI created the concept of accredited investors for IGP listings.

o Eligibility Change: The prior eligibility requirement based on 10% pre-issue

shareholding has been removed; eligibility will now consider the entire pre-issue
shareholding.

o Impact: This broadens the pool of eligible investors.

Conclusion
The amendments made by SEBI to the listing norms of the Innovators Growth Platform are designed to
make it more accessible and attractive for startups in India. By reducing eligibility criteria, relaxing
disclosure requirements, easing delisting procedures, and introducing provisions for differential voting
rights, the IGP aims to foster a conducive environment for the growth of young, innovative companies
while providing investors with new opportunities.

Institutional Trading Platform (with Innovators Growth Platform (with IPO)

IPO)

Applicability Applicability

Company with intensive use of technology, Company with intensive use of technology,
information technology, intellectual information technology, intellectual
property, data analytics, bio-technology or property, data analytics, bio-technology or
nano-technology in their businesses nano-technology in their businesses

Atleast 25% of the pre-issue capital of the Atleast 25% of the pre-issue capital of the
company shall be held by Qualified Issuer shall be held by a set of investors (as
Institutional Buyers detailed in Annexure-I) for a period of
minimum 2 (two years)
Or

Any other company with atleast 50% of its

pre-issue capital held by Qualified
Institutional Buyers

Investor Allocation Investor Allocation

 1. 75% to Institutional Investors with The allotment to Institutional Investors as
no separate allocation for anchor well as Non-institutional investors shall be
investors on a proportionate basis.
2. 25% to Non-institutional Investors
Any under-subscription in the
The allotment to Institutional Investors may Noninstitutional Investor category shall be
be on a discretionary or a proportionate available for subscription under the
basis whereas the allotment to Non- Institutional Investors’ category.
institutional Investors shall be on a
proportionate basis

In case of discretionary allotment to

Institutional Investors, no Institutional
Investor shall be allotted more than 10% of
the issue size.

Investment Parameters Investment Parameters

• Min Allottees in IPO – 200 • Min Allottees in IPO – 50

• Min Application size - INR 10 Lakhs • Min Application size - INR 2 Lakhs
• Min Trading lot size – INR 10 Lakhs • Min Trading lot size - INR 2 Lakhs
Unit 14
Here is a detailed overview of the Social Stock Exchange (SSE) in India, highlighting the regulatory
framework, key features, and developments to date.

1. Regulatory Framework and Establishment

• SEBI established the regulatory framework for the SSE on July 25, 2022, through amendments to
certain SEBI Regulations, and further refined the framework through Circulars on September 19,
2022 and October 13, 2022.

• The National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) have both set up the SSE
segment for social enterprises.

2. Purpose and Significance of SSE

• SSE aims to provide a regulated platform for Not-for-Profit Organizations (NPOs) and social
enterprises to raise funds from investors interested in social impact, thereby channeling greater
capital towards social causes.

• SSE was introduced as a concept by Finance Minister Nirmala Sitharaman in her 2019-2020
Budget Speech.

• SSEs are intended to support private and non-profit sectors by offering a specialized bourse,
similar to Social Stock Exchanges in other countries such as the UK, Canada, Brazil, Singapore,
and others.

3. Registration and Listings on NSE and BSE SSE

• Registration Requirement: NPOs must register on the SSE to raise funds.

• As of June 14, 2024:

o NSE SSE: 65 NPOs registered, with 8 already listed.

o BSE SSE: 51 NPOs registered, as per the Economic Survey 2023-24.

• The first NPO to list on the SSE was the Bengaluru-based SGBS Unnati Foundation in December
2023, which raised approximately ₹1.8 crore from high-net-worth individuals (HNIs).

• Total Funds Raised: Nine NPOs have collectively raised ₹12.4 crore on the SSE.

4. Capacity Building Fund (CBF)

• A Capacity Building Fund (CBF) has been established under NABARD, in collaboration with
NABARD, SIDBI, NSE, and BSE.

• Purpose: The CBF is intended to assist NPOs and stakeholders in understanding the SSE
framework, processes, and available financial instruments, as well as to spread awareness about
SSE.

• Initial Corpus: The initial fund size of the CBF is set at ₹10 crore.
5. Awareness Programs

• SEBI, together with Exchanges, NABARD, SIDBI, ICAI, ICSI, and ICMA, has conducted multiple
awareness programs to educate NPOs and other stakeholders on the structure and functioning
of the SSE.

6. Social Stock Exchange Advisory Committee (SSEAC)

• SEBI has constituted the Social Stock Exchange Advisory Committee (SSEAC) under the
chairmanship of Dr. R. Balasubramaniam, a Member of the Capacity Building Commission, Govt.
of India.

• Role of SSEAC: This committee advises SEBI on the development and growth of the SSE,
providing recommendations on regulatory and operational matters.

7. Disclosure Requirements and Investor Information

• SEBI mandates that NPOs registered with the SSE meet certain minimum requirements and
comply with specific disclosure requirements when raising funds through the SSE.

• Annual disclosures are required for NPOs listed on SSE, including detailed information on fund
utilization and social impact outcomes.

• Investor Knowledge Gap: Many potential investors lack sufficient information about social
enterprises, which can impede the flow of funding.

8. Social Enterprises and Existing Models in India

• Social impact and entrepreneurship are deeply rooted in Indian culture, exemplified by long-
standing cooperative and community-based models such as Amul and Fab India.

• These Social Enterprises (SEs) typically rely on funding from Corporate Social Responsibility
(CSR) contributions, philanthropic donations, crowdfunding, and social
incubators/accelerators.

9. Global Context and Similar SSEs

• SSEs are operational in various countries, including Brazil, Portugal, South Africa, Jamaica, UK,
Canada, and Singapore.

• These platforms serve as unified funding channels for listed social enterprises, potentially
uplifting enterprises serving socio-economically disadvantaged communities.

10. Significance During the Pandemic

• The SSE concept gained momentum during the COVID-19 pandemic, underscoring the need for
sustainable social capital to support organizations engaged in social welfare.

• By providing a formal platform for social enterprises to raise funds, SSE enables organizations
working on social issues to access funding channels typically unavailable to them through
conventional capital markets.
Conclusion

The Social Stock Exchange in India represents a pioneering step towards formalizing and enhancing the
flow of capital to social enterprises and NPOs. Through regulatory frameworks, capacity-building
initiatives, and transparency requirements, SEBI has created a supportive environment for socially driven
organizations, allowing them to achieve greater visibility, attract diverse investors, and contribute to
India’s social welfare objectives.

1. Definitions and Entities Involved

• For-Profit Social Enterprise: A company or corporate body operating for profit that qualifies as a
Social Enterprise under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.

• Not-for-Profit Organization (NPO): Social Enterprises registered under various legal structures,
including:

o Charitable trusts (Indian Trusts Act, 1882 or state statutes)

o Societies (Societies Registration Act, 1860)

o Section 8 companies (Companies Act, 2013)

o Any other entity specified by SEBI.

• Social Enterprises: Encompasses both Not-for-Profit Organizations (NPOs) and For-Profit Social
Enterprises meeting eligibility under Chapter X-A of SEBI Regulations, 2018.

• Social Stock Exchange (SSE): A dedicated segment of recognized stock exchanges (with
nationwide trading access) that registers NPOs and lists securities issued by NPOs as per SEBI
guidelines.

2. Zero Coupon Zero Principal Instruments (ZCZP)

• Definition: Instruments issued by NPOs registered on the SSE segment of a recognized stock
exchange, allowing them to raise funds without regular debt-like interest or principal repayment.

• Characteristics:

o Zero Coupon: No interest paid to the instrument holder.

o Zero Principal: No principal repayment; instrument has no maturity value.

• Eligibility and Issuance Requirements:

o Form: ZCZPs must be issued in dematerialized form.

o Minimum Issue Size: ₹1 crore.

o Minimum Application Size: ₹2 lakhs.

• Objective: Enables NPOs to fundraise for specific social projects or goals without burdening
them with traditional debt obligations.
3. Criteria for Identifying as a Social Enterprise

• Objective: Social Enterprises are defined as entities that work to address societal challenges and
balance social impact with financial returns.

• Operations: These organizations often provide products or services that benefit society, such as
organic foods or affordable services, while sometimes facing funding challenges to sustain
operations.

4. Means of Fundraising for Social Enterprises via SSE

• Purpose: SSE provides Social Enterprises with access to traditional financial markets to help
overcome funding challenges.

• Fundraising Mechanisms:

o Social Enterprises can raise funds by issuing ZCZPs or other instruments as per SEBI
guidelines.

o This channel enhances visibility for Social Enterprises, potentially attracting a wider
range of investors.

5. Minimum Requirements for SSE Registration

• NPO Registration: NPOs must meet specific requirements under SEBI’s ICDR Regulations to
register on the SSE.

• Eligibility Criteria: Defined by SEBI in Chapter X-A of the SEBI Regulations, ensuring transparency
and accountability in social impact projects.

6. Disclosure Requirements for Social Enterprises

• Not-for-Profit Organizations (NPOs):

o Annual Disclosures: Covering general, governance, and financial aspects within 60 days
post-financial year-end.

o Quarterly Fund Utilization Statements: Due within 45 days of each quarter, until funds
are fully utilized or goals achieved.

• For-Profit Social Enterprises:

o Compliance with SEBI ICDR: Follow standard disclosure norms applicable to companies
listed on the Main Board, SME Exchange, or Innovators Growth Platform.

• General Disclosure for All Social Enterprises:

o Material Event Reporting: Notify SSE or other stock exchanges of any events significantly
impacting output or outcomes within seven days or as per SEBI requirements.

o Annual Impact Report (AIR): Must include qualitative and quantitative data on social
impact, covering projects funded through SSE. This report is due within 90 days post-
 financial year-end and must be audited by a social audit firm with certified social
auditors.

7. Annual Impact Reporting and Social Audit Requirements

• Annual Impact Report (AIR):

o Required from all registered social enterprises, covering both organizational and project-
specific impact.

o The report must be audited by a certified social auditor from a recognized social audit
firm.

o Provides investors and stakeholders with transparency on social outcomes achieved,

fulfilling SSE’s commitment to accountability.

Summary

The SSE provides a structured platform for Social Enterprises, especially NPOs, to access capital through
the issuance of innovative financial instruments like ZCZPs. This framework, developed by SEBI, includes
stringent eligibility, disclosure, and reporting requirements to ensure that social impact and financial
accountability go hand-in-hand. Through these measures, the SSE enhances the capacity of social
enterprises to fulfill their missions, bringing in transparency and investor trust in socially beneficial
projects.

Eligibility Conditions for Social Enterprises under the Social Stock Exchange (SSE) Framework

The Social Stock Exchange framework, under Section 292E, Chapter X–A of the SEBI ICDR Regulations
2018, establishes the conditions and roles for identifying, registering, and supporting Social Enterprises
(SEs).

A. Eligibility Criteria for Social Enterprises (SEs)

To be identified as a Social Enterprise, entities must meet the following conditions:

1. Social Activities Requirement: The SE must engage in at least one of the following 16 approved
activities, or in any other area as identified by SEBI or the Government of India:

o Eradication of hunger, poverty, malnutrition, and inequality

o Promotion of healthcare, including mental healthcare and sanitation

o Provision of safe drinking water

o Promotion of education, employability, and livelihoods

o Gender equality and empowerment of women and LGBTQIA+ communities

o Environmental sustainability, including climate change mitigation and wildlife

conservation
 o Protection of national heritage, art, and culture

o Training in rural, Paralympic, Olympic, and nationally recognized sports

o Support for incubators and other platforms strengthening the non-profit ecosystem

o Promotion of livelihoods for rural and urban poor, including enhancing income for small
farmers

o Slum area development, affordable housing, and sustainable city-building interventions

o Disaster management and relief activities

o Financial inclusion initiatives

o Facilitation of land and property access for disadvantaged communities

o Bridging the digital divide, addressing misinformation, and enhancing data protection

o Welfare for migrants and displaced persons

2. Target Population and Social Impact: The SE must primarily serve underserved or less privileged
populations or regions identified by central or state governments as having lower performance
on development priorities.

3. Activity Proportion (67% Rule): At least 67% of the SE's recent three-year average activities must
align with the target social impact criteria, as evidenced by:

o Revenue: 67% of average revenue must be from providing eligible activities to the target
population.

o Expenditure: 67% of average expenditure must be on eligible activities for the target
population.

o Beneficiaries: 67% of the SE's average customer or beneficiary base must come from the
target population.

B. Role of Social Stock Exchanges (SSEs)

The SSE framework is designed to facilitate, monitor, and regulate the capital-raising efforts of SEs in
India, ensuring fund safety, efficient utilization, and a transparent capital formation process. The SSE
framework aims to:

1. Mobilize Funds: Help SEs access funds needed for development.

2. Promote Capital Formation: Provide a reliable, regulated platform for SEs to raise capital.

3. Ensure Fund Security: Monitor fund utilization to ensure it aligns with social objectives.

4. Enhance Visibility: Provide a nationwide platform for SE capital formation, thereby boosting
exposure and investor interest.

5. Fundraising for Development: SSEs ensure that funds raised are confined to genuine social
causes, maintaining credibility and transparency in the social sector.
C. Regulatory Framework for Social Stock Exchanges

The regulatory framework for SSEs is structured through specific amendments to SEBI regulations,
mandating stringent eligibility, reporting, and disclosure requirements:

• Mandatory Listing for NPOs: Only listed NPOs are allowed to raise funds via Zero Coupon Zero
Principal (ZCZP) instruments, and securities must be registered in the SSE segment of a
recognized stock exchange.

• Amendments by SEBI:

o SEBI (LODR) Regulations 2015 (July 2022): Introduced Chapter IX–A, containing
regulations for the registration, fund-raising avenues, and reporting obligations of SEs.

o SEBI (ICDR) Regulations 2022 (Third Amendment): Chapter X-A specifically addresses
SSE operations and lays down criteria for SEs, fund-raising avenues, issuance procedures,
and reporting obligations.

D. SEBI Disclosure and Reporting Requirements for SEs

SEBI has established specific disclosure and reporting obligations for registered SEs, helping to ensure
transparency and accountability:

• Annual Disclosures for NPOs: Registered NPOs must disclose general, governance, and financial
information within 60 days of the fiscal year-end (Reg. 91C).

• Material Event Disclosure: SEs must report any material event impacting project outcomes to
SSEs within seven days of the event (Reg. 91D).

• Annual Impact Report (AIR): SEs registered with an SSE must submit an audited report detailing
the social impact of funded activities within 90 days of the fiscal year-end (Reg. 91E).

• Quarterly Fund Utilization Report: NPOs must submit quarterly statements on fund usage,
including the category-wise breakdown of raised and utilized funds, until the funds are fully
utilized or the project goal is achieved (Reg. 91F).

This comprehensive SSE framework, developed and regulated by SEBI, allows Social Enterprises to access
structured capital for social causes while ensuring high standards of transparency, impact measurement,
and investor protection in India’s social sector.
 Unit 15
Decentralization in Organizational Structure

Decentralization is an organizational structure in which top management delegates decision-making

authority and daily operations to middle and lower-level managers. This approach allows top
management to focus on major strategic decisions, freeing time and resources for broader, high-level
planning and potential expansion.

In a decentralized structure, middle and lower management are entrusted with responsibilities including
planning, strategizing, and making operational decisions. This structure can enhance productivity at
every level, ultimately contributing to improved overall performance.

Advantages of Decentralization

1. Motivation of Subordinates:

o Decentralization boosts job satisfaction and morale, especially among lower-level

managers. It encourages participation, independence, and a sense of status, fostering a
spirit of group cohesiveness and teamwork.

2. Growth and Diversification:

o Product divisions in a decentralized system enjoy autonomy, allowing for creative

problem-solving and healthy competition between divisions. Decentralization also helps
in skill development, succession planning, and ensures organizational growth and
continuity.

3. Quick Decision-Making:

o Decisions are made by authorized personnel who are familiar with the situation,
resulting in faster, more accurate decisions tailored to real-time circumstances.

4. Efficient Communication:

o Fewer hierarchical levels improve the efficiency of communication, fostering close

relationships between superiors and subordinates and reducing communication delays.

5. Ease of Expansion:

o Decentralization supports business expansion, especially into new geographical

locations, by leveraging the organization's full potential and tailoring operations to
specific regional needs.

6. Better Supervision and Control:

o Lower-level managers with adequate authority can make adjustments, discipline, and
evaluate their teams, improving supervision. Performance evaluations of decentralized
units also enhance control over operations.

7. Relief for Top Executives:

 o With operational decisions managed by lower levels, top executives can focus on high-
level planning and decision-making, reducing their workload and benefiting the
organization as a whole.

Disadvantages of Decentralization

1. Difficult to Coordinate:

o Substantial autonomy for each division can create coordination challenges, complicating
the alignment of overall organizational activities.

2. External Factors:

o Factors such as trade unions, market uncertainties, and government regulations can
sometimes hinder the effectiveness of decentralization.

3. Narrow Product Lines:

o Decentralized systems require broad product lines for each autonomous unit to thrive.
Smaller businesses with narrow product lines may struggle to decentralize effectively,
especially if there is a lack of skilled managers.

4. Expense:

o Decentralization often requires paying employees more to take on greater responsibility

and ownership of organizational objectives, which can be costly for the organization.

In conclusion, while decentralization has numerous advantages such as faster decision-making, increased
employee satisfaction, and streamlined communication, it also poses challenges including coordination
difficulties, potential external disruptions, and added costs. For businesses considering decentralization,
it’s essential to weigh these factors against their specific goals and resources.

Decentralization of Governance & Management in the Tech Era

Decentralization in the governance and management of distribution networks has gained prominence,
primarily driven by technological advancements and shifting consumer expectations. Centralized
distribution once dominated due to its cost-effectiveness in inventory, transportation, and storage.
However, the tech-driven demand for faster, more responsive delivery has sparked a shift toward
decentralized models.

Key Factors Driving Decentralization in the Tech Era

1. Changing Consumer Expectations:

o Modern consumers prioritize fast delivery over cost savings achieved by centralized
systems. Research indicates that 96% of consumers in mature markets expect same-day
or even same-hour delivery, yet only half of retailers can meet this demand. Companies
like Amazon are leading this trend with rapid delivery promises, achieved by maintaining
multiple smaller warehouses in various locations.
 2. Rise of Decentralized Warehousing:

o Decentralized warehouse networks are now the preferred fulfillment model for major
players. These networks reduce shipping times by positioning inventory closer to
consumers, catering to the demand for faster last-mile deliveries. Small and medium
enterprises (SMEs), however, often lack the resources for decentralized infrastructure
and increasingly rely on third-party logistics (3PL) providers to meet these fulfillment
needs.

3. Last-Mile Delivery Challenges:

o Last-mile delivery—getting goods from warehouses to consumers' homes—remains one

of the most complex parts of the supply chain due to factors like traffic, customer
availability, and returns. Many companies are outsourcing last-mile logistics to 3PL
providers who bring specialized technology and expertise to address these challenges.

4. Supply Chain as a Service (SCaaS):

o The shift toward decentralized distribution is bolstered by the emergence of SCaaS,

supported by advanced technology such as transportation management systems, cloud-
based SCM software, blockchain, and data integration tools. These innovations help
organizations manage distributed warehouse networks more efficiently.

5. Enterprise Resource Planning (ERP) Systems:

o Managing inventory across decentralized warehouses requires real-time data,

automation, and accurate inventory tracking. ERP systems facilitate these processes by
automating tasks like inventory replenishment and stock accuracy, which is essential for
managing multiple warehouses efficiently.

6. Warehouse Space Shortages:

o Despite the push for decentralization, the availability of land for warehouse
development is a significant barrier. In the U.S., warehouse vacancy rates have dropped
to historic lows, indicating a shortage that can limit further decentralization in certain
areas.

Advantages and Challenges of Decentralized Supply Chains

Advantages:

• Faster Delivery: With inventory located closer to customers, businesses can significantly reduce
delivery times, meeting consumer demand for speed.

• Improved Customer Satisfaction: Enhanced fulfillment capabilities help reduce customer churn
and build loyalty.

• Scalability with 3PL Providers: SMEs and even large companies can scale their operations by
partnering with 3PLs, avoiding large investments in infrastructure.

Challenges:
 • Coordination Complexity: Multiple, dispersed warehouses increase the complexity of managing
inventory, replenishment, and order accuracy.

• Higher Operational Costs: Decentralized systems may incur higher costs related to facility
management and distribution.

• Land and Resource Constraints: Limited land availability restricts expansion possibilities in some
areas.

The Future of Decentralized Distribution Networks

The decentralization of governance and management in supply chain operations is increasingly a

strategic move. While centralization focused on cost efficiency, decentralization in today’s tech era
prioritizes speed, flexibility, and scalability. As technology continues to evolve, supply chains are
becoming more agile and responsive to consumer needs, providing organizations with the tools
necessary to stay competitive.

With ERP systems and SCaaS models automating and optimizing the process, decentralized distribution
networks are becoming not just viable but essential, marking a significant transformation in supply chain
management strategies.

The Amazon Way - Decentralized Corporate Governance and Management

1. Corporate Governance Evolution:

o Modern corporate governance has improved, but centralized governance can struggle
with issues like agency and knowledge problems.

o Decentralized governance allows employees to monitor each other, potentially closing

governance gaps.

2. Board of Directors:

o Amazon's Board oversees major decisions and provides organizational oversight,

combining independent directors and Amazon executives at the highest governance
level.

3. Leadership Principles:

o Amazon uses 16 Leadership Principles as a cultural and decision-making guide, enabling

decentralized decisions aligned with Amazon’s vision.

4. Business Units and Divisions:

o Amazon's diverse business units (e.g., AWS, Prime, Retail) operate with significant
autonomy, allowing specialized decision-making within each area.

5. Local and Regional Decision-Making:

o Decentralization varies by business unit and region, such as retail managers having
control over product selection to better serve local markets.
 6. Data-Driven Decision-Making:

o Amazon emphasizes data and customer insights across teams to inform and drive
decision-making processes.

7. Customer-Obsessed Culture:

o Decisions at all levels prioritize customer satisfaction, supporting Amazon's focus on

being "customer-obsessed."

8. Bottom-Up Innovation:

o Amazon encourages innovation from all employees, giving individuals freedom to

introduce new ideas and initiatives.

9. Inclusive and Diverse Teams:

o The company promotes diversity and inclusivity, believing that diverse teams create
more effective solutions.

10. Long-Term Thinking:

• Amazon’s leadership focuses on long-term goals, even if it means sacrificing short-term profits
for sustained growth and customer loyalty.

Meta (Facebook) - Centralized Corporate Governance

1. Corporate Governance Guidelines:

o Meta's Board adopts guidelines to ensure sound governance practices, supporting both
policy and decision-making at the Board and management levels, aimed at long-term
shareholder value.

2. Responsibilities of the Board of Directors:

o Advises and monitors management, reviews significant transactions, and sets

transaction standards.

o Selects and appoints the CEO, Chairperson, and Lead Independent Director, if necessary.
The CEO appoints other officers, subject to Board or committee approval as needed.

3. Board Member Commitment:

o Directors are expected to commit sufficient time and effort, including regularly attending
meetings and reviewing materials in advance.

4. Board Independence:

o Despite Meta’s “controlled company” status, the Board is composed of a majority of

independent directors, evaluated annually.

5. Shareholder Communication with the Board:

 o Shareholders can communicate with the Board via the corporate secretary, specifying
the addressee, topic, and class of stock owned.

o Meta’s corporate secretary filters communications, forwarding only relevant, non-

commercial messages to the appropriate addressees.

Key Differences: Amazon vs. Meta

• Governance Approach: Amazon leans toward a decentralized approach, empowering employees

and divisions for localized decision-making, while Meta maintains a centralized, traditional
governance structure.

• Board Role: Both companies have Boards with oversight responsibilities, but Amazon’s Board is
part of a broader decentralized framework, whereas Meta's Board functions as a central
advisory body with a structured process for major decisions.

• Cultural Priorities: Amazon’s culture is driven by customer obsession and bottom-up innovation,
while Meta emphasizes shareholder value and compliance through a structured governance
framework.
 UNIT 16
Insider Trading Overview

1. Definition: Insider trading involves using confidential, unpublished price-

sensitive information (UPSI) to trade in a company’s securities. Such information
is typically related to Board decisions and is undisclosed to the general public.
2. Nature of Information: UPSI can influence a company’s stock price when
disclosed, making it “price-sensitive.” The use of this information for personal
gain or to prevent losses constitutes insider trading.
3. Actions Constituting Insider Trading: Insider trading encompasses any
activity—buying, selling, or subscribing—related to a company’s securities by
individuals (often key management personnel or directors) who have access to
UPSI.

Characteristics and Example of Insider Trading

1. Basis of Insider Trading: This practice hinges on the voluntary exchange of

securities based on confidential information not available to the public,
potentially affecting the price of those securities significantly.
2. Example: If a director, aware of poor financial conditions, sells shares before
a public dividend cut announcement or buys shares before disclosing a valuable
discovery (e.g., diamonds on company land), they are engaging in insider trading.

Legal Position in India

1. Trading Permissions: In India, company insiders may trade their company’s

stocks if they disclose transaction records to maintain transparency.
2. SEBI’s Role: The Securities and Exchange Board of India (SEBI) enforces
disclosure regulations to ensure transparency and build investor confidence.
Insider trading, when carried out unlawfully, is punishable by law.

Who is an Insider?
 1. Definition: “Insiders” are individuals with access to confidential, price-
sensitive information about a company, often using it to gain an advantage over
uninformed investors.
2. Who Qualifies as an Insider?: Insiders can include:
• Partners, directors, officers, and employees.
• Those with official relationships (auditors, consultants, bankers, brokers).
• Stakeholders, government officials, stock exchange employees, and
individuals with professional or business ties that provide UPSI access.
3. System Weaknesses: Insiders might share UPSI with outsiders, allowing the
outsider to profit without directly implicating the insider. Identifying such
loopholes is crucial to safeguarding fair trading practices.

Unpublished Price-Sensitive Information (UPSI)

1. Definition of UPSI: UPSI is any information that, if disclosed, could impact a

company’s securities’ market price and is typically tied to internal company
decisions.
2. Examples of UPSI: Financial statements, dividend declarations, mergers or
amalgamations, stock buy-backs, de-mergers, and operational policy changes.
3. Fair vs. Unfair Trading: Trading under regulatory compliance is “fair
trading,” while exploiting UPSI for gains constitutes “unfair trading” or insider
trading.

Ethical and Moral Implications

• Unfair Advantage: Sharing UPSI in the market creates an unfair advantage

for those possessing the information, disadvantaging uninformed traders. Such
practices are unethical and counter to market integrity.

SEBI Regulations on Insider Trading

1. Prohibition Under Indian Law: The Companies Act, 2013, and the SEBI Act,
1992 prohibit insider trading.
 2. SEBI (Prohibition of Insider Trading) Regulations, 2015: These
regulations detail the prohibitions and restrictions related to insider trading in
India.
3. SEBI Amendments in 2018:
• Apply mainly to listed securities and define “dealing in securities” as any
buying, selling, or trading conducted by insiders based on confidential
information.
• Prohibit unauthorized communication or sharing of UPSI by insiders.
• If any individual breaches these regulations, they face severe penalties: up to
10 years of imprisonment or fines up to 25 crores.
4. SEBI’s Investigative Powers: SEBI holds the authority to investigate
allegations of insider trading and related misconduct.

SEBI’s Powers of Investigation

1. Purpose of SEBI’s Investigation:

• Investor Complaints: SEBI can investigate complaints from investors,
intermediaries, or any person regarding potential insider trading violations.
• Self-Initiated Investigations: SEBI may also investigate based on its own
knowledge or information to protect investor interests and enforce insider
trading regulations.
2. Liability of Promoters:
• Under SEBI regulations, promoters are held accountable for insider trading
violations if they misuse unpublished price-sensitive information (UPSI),
regardless of their shareholding, unless it’s for a legitimate purpose.
3. Exceptions to Insider Trading Prohibitions:
• Disclosure for Legitimate Purposes: Disclosure of UPSI is permitted when
necessary for duties, legal obligations, or legitimate business purposes. For
instance, in Dirks v. SEC, individuals like lawyers or accountants may be deemed
insiders if they are given UPSI during the course of business.
• Disclosure Obligations: Disclosure is also allowed in cases where there’s a
requirement for an open offer or if it’s in the company’s best interest. Samir
Arora v. SEBI held that for insider trading provisions to apply, UPSI must be
accurate and true.
Disclosure Requirements

1. Initial Disclosure:
• Promoters, Key Managerial Personnel (KMP), and Directors of listed
companies must disclose their holdings of company securities (via Form 4)
within 30 days of the SEBI regulations taking effect.
2. Continual Disclosure:
• Promoters, designated employees, and Directors must disclose any
acquisition or disposal of securities (using Forms 5 & 6) within two trading
days if the traded value in a calendar quarter exceeds Rs. 10 lakhs or another
specified limit.

Structured Digital Database (SDD) – Key Concerns

1. Mandatory Maintenance:
• Since April 1, 2019, maintaining an SDD has been compulsory under SEBI’s
Prohibition of Insider Trading Regulations, 2015 (PIT Regulations).
2. Database Requirements:
• Details Captured: The SDD must contain the nature of UPSI, names of those
who shared it, and recipients’ names along with Permanent Account Numbers
(PAN) or other legal identifiers if PAN isn’t available.
• Internal Management: The database must be maintained internally with
controls such as time-stamping and audit trails to prevent tampering.
3. Compliance and Certification:
• From June 30, 2022, companies are required to submit a compliance
certificate from the Compliance Officer based on requests from the stock
exchanges where their securities are listed.
4. Preservation Period:
• The SDD must be preserved for at least eight years after transaction
completion. If SEBI initiates an investigation or enforcement proceedings, the
database should be preserved until those proceedings are concluded.
Designated Persons – Definition and Roles

1. Definition: “Designated Persons” are employees or individuals designated by

the Board of Directors, based on their roles and functions, who are reasonably
likely to have direct or indirect access to unpublished price-sensitive information
(UPSI) related to the company.
2. Inclusion Criteria:
• Designated Persons include:
• Company Directors
• General Managers
• Chief Financial Officer (CFO)
• Company Secretary
• Any Employee or Outsider with UPSI access
• Other Employees determined by the Compliance Officer in
consultation with the Board, who may have access to UPSI as part of their
role.
3. Responsibilities:
• Employees are expected to refrain from trading in the company’s securities if
they possess UPSI or when the trading window is closed.

Restrictions on Designated Persons

1. Trading Restrictions:
• Designated Persons may not trade (directly or indirectly) in the company’s
securities if they possess UPSI or when the Trading Window is closed,
regardless of whether they hold UPSI at that time.
 2. Communication of UPSI:
• They cannot share, provide, or give access to UPSI, whether directly or
indirectly, except for:
• Legitimate purposes (as outlined in the company’s policy),
• Performance of duties, or
• Legal obligations.
• Passing UPSI to any person for securities trading recommendations or any
other purpose is prohibited.
3. Compliance with the Trading Window:
• Monitoring Trades: Trades by Designated Persons and their immediate
relatives are monitored through a notional trading window, which closes or re-
opens based on UPSI availability.
• Trading Window Closures:
• The Compliance Officer may close the Trading Window when any
Designated Person is expected to have UPSI.
• Immediate relatives of Designated Persons are also restricted from
trading when the window is closed.
• The window reopens once UPSI becomes publicly available.
• Quarterly Trading Window Closure: The trading window closes at the end
of each quarter and remains closed until 48 hours after the company’s financial
results are publicly declared.
4. External Advisors:
• The Trading Window rules also apply to External Advisors who might have
access to UPSI.
5. Onus of Communication:
• It is the responsibility of Designated Persons and their immediate relatives to
inform their immediate relatives about the status of the Trading Window.

Role of Compliance Officer under SEBI (Prohibition of Insider

Trading) Regulations, 2015
 1. Primary Responsibilities:
• Acts as a “watchdog” ensuring that unpublished price-sensitive information
(UPSI) is handled with care and not misused.
• Ensures individuals with access to UPSI do not trade in the company’s shares
or misuse this information.
• Makes timely disclosures to stock exchanges as required.
2. Qualifications and Positioning:
• Must be a senior officer reporting to the board of directors or head of the
organization if no board exists.
• Should be financially literate and capable of understanding legal and
regulatory requirements.
• Responsible for ensuring compliance with policies, maintaining records,
monitoring adherence to rules regarding UPSI, and implementing codes under
the Regulations.
3. Code of Fair Disclosure:
• Formulates a Code of Practices and Procedures for Fair Disclosure for
UPSI and establishes a policy to determine “legitimate purposes” while
adhering to the Regulations.
• Publishes this code on the official website and notifies stock exchanges of any
updates.
4. Code of Conduct:
• Develops and administers a code of conduct to regulate, monitor, and
report trading by employees and connected persons.
• Covers designated persons based on their roles and the access level to UPSI.
• Ensures compliance by sending email reminders to designated persons about
trading restrictions, collecting annual confirmations under the Code, and
overseeing the code’s application.

Case: Hindustan Lever Limited (HLL) v. SEBI

 • Facts: HLL acquired shares of Brooke Bond Lipton India Ltd. (BBLIL) shortly
before announcing a merger with BBLIL. SEBI deemed HLL an “insider,” as they
had access to UPSI concerning the merger.
• SEBI’s Decision: SEBI classified HLL as an insider due to its management ties
with BBLIL (both subsidiaries of Unilever). SEBI held that HLL’s possession of
merger-related UPSI and prior knowledge rendered it liable under insider trading
regulations.
• Appeal: HLL appealed, claiming the merger information was generally known
and hence did not qualify as UPSI. While the Appellate Authority acknowledged
the public knowledge argument, it agreed that the merger information was indeed
price-sensitive.

This case underscores the significance of the Compliance Officer’s role in monitoring
UPSI-related trades and implementing codes to prevent misuse.

Recent Amendments and Updates to SEBI Insider Trading

Regulations

1. 2023: SEBI proposed reviewing the UPSI definition to align it with material
events under Listing Regulations, aiming to ensure consistent compliance.
2. 2022: Amended regulations to cover mutual fund (MF) transactions
specifically, adding clarity on UPSI handling in MF units, and applying SEBI’s
informant mechanism and provisions to these transactions.
3. 2021: Removed Regulation 7(1)(a), which required promoters and key
personnel to disclose holdings upon the Regulations’ initial effect. This regulation
was deemed redundant.
4. 2020: Enhanced the digital database to capture and automate shareholding
disclosures and reporting of violations, increasing compliance transparency and
establishing structured mechanisms as exceptions to trading window
restrictions.

These updates demonstrate SEBI’s ongoing efforts to refine insider trading

regulations, ensuring a more structured and technology-driven approach to UPSI
compliance.
UNIT 17
SEBI's Prohibition of Fraudulent and Unfair Trade Practices (PFUTP) Regulations (July 17, 2003)

1. Definition of Fraud (Regulation 2(1)(c))

• Fraud includes any act, expression, omission, or concealment committed (deceitfully or

otherwise) by a person or any other individual with their collaboration, or by their agent while
dealing in securities.

• This act is intended to induce others or their agents to trade securities, whether or not resulting
in wrongful gain or avoidance of loss.

Examples:

• Manipulating financial reports to lure investors into buying stocks.

• Front-running: Buying shares of a company based on non-public information received and later
selling those shares to the original source of information for profit.

2. Regulation 3 – Prohibition of Certain Acts in Securities Trading

No individual shall, directly or indirectly:

• (a) Engage in buying, selling, or otherwise trading securities fraudulently.

• (b) Use or employ any manipulative or deceptive device in the issue, purchase, or sale of
securities that contravenes regulatory provisions.

• (c) Use any device or scheme to defraud in relation to listed or proposed securities.

• (d) Engage in any activity that operates as fraud or deceit in connection with dealing in listed or
proposed securities in contravention of regulatory provisions.

3. Regulation 4 – Prohibition of Manipulative, Fraudulent, and Unfair Trade Practices

2022 Amendment: No individual shall engage in manipulative, fraudulent, or unfair trading practices in
the securities market.

Deemed Manipulative, Fraudulent, or Unfair Practices Include:

• False Appearance of Trading: Acts that knowingly create a misleading appearance of trading in
the securities market.

• False Information: Publishing or reporting untrue information about securities (e.g., financial
statements, mergers) in connection with securities trading.

• Misleading News: Intentionally spreading false or misleading news to induce security sales or
purchases.
 • Fraudulent Inducement: Persuading individuals to subscribe to securities by fraudulently
securing minimum subscriptions through advances or promises of funds.

• Artificial Price Manipulation: Influencing security prices by inflating, depressing, or causing

fluctuations through financial inducements.

• Price Manipulation: Manipulating the reference or benchmark price of securities.

• Dealing in Stolen/Fraudulent Securities: Selling, dealing, or pledging securities that are stolen,
counterfeit, or fraudulently issued (physical or dematerialized).

• False Media Information: Disseminating false information or advice through media to influence
investor decisions.

• Unauthorized Client Transactions: Market participants trading on behalf of clients without their
knowledge or diverting client funds or securities.

• Circular Transactions: Circular trades between persons, including intermediaries, to artificially

affect security price or volume.

• Brokerage or Commission Fraud: Fraudulently inducing clients to trade securities to increase

brokerage or commission income.

• Record Falsification: Intermediaries falsifying records such as contract notes, client instructions,
and account statements.

• Insider Trading: Placing orders based on non-public information regarding an impending

substantial transaction in a security or derivative.

• Mis-selling of Securities: Misrepresenting securities or services in the securities market.

Summary of Key Points

• Scope of Fraud: Broadly defined to include deceitful or collaborative acts to induce security
trades.

• Prohibitions: Regulations prohibit fraudulent, manipulative, or deceptive trading practices in all

securities dealings.

• Deemed Practices: Specific actions, such as price manipulation, insider trading, and
unauthorized client transactions, are categorized as unfair practices.

• 2022 Amendments: Reinforce prohibitions against manipulative practices, emphasizing

technology, media influence, and insider trading concerns in modern securities trading contexts.

SEBI Act Section 12 and Related Regulations

1. Definition of Market Participant (Section 12)

Entities considered as “market participants” under the SEBI Act include:

• Stock broker

• Sub-broker

• Share transfer agent

• Banker to an issue

• Trustee of a trust deed

• Registrar to an issue

• Merchant banker

• Underwriter

• Portfolio manager

• Investment adviser

• Any other intermediary associated with the securities market

2. Key Regulations and Amendments

• Regulation 6: Custody of Documents

The previous one-month retention period has been extended, allowing custody of any books,
registers, documents, and records for up to six months.

• Regulation 7: Information Requests

SEBI can call for information and records from any person, including banks or other authorities,
regarding securities transactions under investigation.

• Regulation 8: Application for Seizure

SEBI's Investigating Authority can request a court order from a designated Mumbai judge to seize
documents if they reasonably believe these records may be destroyed, altered, or falsified.

• Regulation 9: Retention of Seized Documents

SEBI can keep seized documents until the investigation concludes. Before returning them, SEBI
may mark or identify the documents.

• Regulation 10: Procedure for Searches and Seizures

Searches and seizures must adhere to the Code of Criminal Procedure, 1973, ensuring
regulatory compliance during enforcement.

• Regulation 15 (HA): Penalty for Fraudulent and Unfair Trade Practices

Penalties for engaging in fraudulent or unfair practices are substantial:

o Minimum fine: ₹5 lakh

 o Maximum penalty: ₹25 crore or three times the profit made from such practices,
whichever is higher.

• Regulation 11 A: Service of Summons and Notices

SEBI outlines specific methods to serve notices, including:

1. Direct delivery or through an agent

2. Electronic delivery: Fax, email, messaging services, or by courier/post

3. Alternative methods if initial attempts fail:

▪ Posting notice on the premises' door if known last residence or business location
is accessible

▪ Publishing in two newspapers, one in English with nationwide reach, the other in
a regional language

Front-Running in Securities

• Definition and Nature of Front-Running

Front-running is a manipulative, unethical, and illegal practice in which an individual or broker
buys or sells securities based on non-public information regarding an impending large
transaction (or “Big Client Order”) that will likely affect security prices.

• Characteristics of Front-Running

o Involves pre-emptive buying or selling before a significant transaction.

o The activity leverages non-public information to gain an unfair advantage.

o Considered a form of market manipulation and insider trading as it exploits confidential

data.

o Brokers or analysts may engage in front-running by using personal accounts in

anticipation of firm transactions.

• Regulation Reference
Regulation 4(2)(q) of the PFUTP Regulations (2003) prohibits front-running by any person
holding direct or indirect non-public information regarding a substantial transaction.

SEBI's Regulation and Enforcement of Front-Running in India

1. Background and Definition of Front-Running under SEBI Regulations

• Initial Recognition (1995): SEBI acknowledged front-running as a manipulative and unfair

practice in its 1995 Consultative Paper, later incorporating it into the 1995 PFUTP Regulations
(Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market).
 • Defined in 2014 and 2012 Circulars: SEBI defined front-running as using non-public information
to trade in securities ahead of a substantial order to benefit from anticipated price movements
once the information becomes public.

• Current PFUTP Regulations (2003): Regulation 4(2)(q) deems trading based on non-public
information regarding an impending substantial transaction as manipulative and fraudulent.

Key elements to identify front-running:

• Possession of non-public information about a forthcoming large order (“Big Client Order”).

• Pre-emptive trading by the alleged front-runner based on this non-public information before the
Big Client Order is fully executed.

2. Front-Running vs. Insider Trading

• Similarity: Both involve trading based on non-public information, leading to market abuse and
unfair gains.

• Distinction in Indian Jurisdiction: Although front-running is similar to insider trading, SEBI treats
them as separate offences under the PFUTP Regulations rather than insider trading laws.

• Global Comparison: In some jurisdictions like Singapore, front-running has been prosecuted
under insider trading laws. In India, however, front-running remains regulated distinctly under
PFUTP.

3. Enforcement Powers and Penalties

• Penalties under SEBI Act: SEBI may impose penalties of up to ₹25 crore or three times the
profits made from such practices, whichever is higher.

• Civil and Criminal Proceedings: SEBI can initiate civil proceedings under the SEBI
(Intermediaries) Regulations, 2008, and criminal proceedings under Section 24 of the SEBI Act.

• Section 11/11B Powers: SEBI can issue orders for prohibitory action and other protective
measures in cases involving fraudulent and unfair practices.

4. Case Study: Vibha Sharma & Others vs. SEBI

• Facts of the Case: Jitender Sharma, an equity dealer at Central Bank of India, allegedly shared
upcoming trade information with his wife, Vibha Sharma. SEBI's investigation showed matched
buy-sell trades between CBI's purchase orders and Vibha's sale orders across multiple trading
days.

• Decision of SEBI: SEBI's Adjudicating Officer penalized Vibha Sharma and Jitender Sharma with a
fine of ₹25,00,000 for violating Regulations 3 and 4(1) of the FUTP Regulations.
 • Appeal to SAT: Vibha Sharma appealed the decision, questioning if front-running applies to non-
intermediary traders.

• SAT Order and Observations: SAT upheld SEBI’s decision, noting:

o Front-running is detrimental, irrespective of the individual's status as an intermediary or

private trader.

o A liberal interpretation of front-running is necessary to prevent misuse and unfair

advantage based on non-public information.

o The consistent matching of trades between Vibha’s account and CBI’s orders pointed to a
pattern that could not be explained by coincidence.

This case illustrates SEBI's robust approach to curbing front-running and reinforces that front-running is
detrimental to market fairness, even if conducted by individuals without an intermediary role.
UNIT 18
Ease of Doing Business (EoDB) Index: Overview and Discontinuation

1. Introduction to Ease of Doing Business (EoDB) Index

• Established by the World Bank Group: The Ease of Doing Business Index was launched by the
World Bank Group in 2003 to assess the regulatory environment for businesses in various
economies.

• Ranking System: A higher ranking (i.e., a lower numerical value) in the index indicates a better
regulatory environment that supports business activities and stronger protections for property
rights.

• Calculation Method: The EoDB ranking is based on the distance to frontier (DTF) score, which
measures how close a country's regulations are to global best practices. The DTF score is
aggregated from various indicators of business regulations.

2. Parameters of the EoDB Index

The EoDB index evaluates 10 key areas of business regulation across 190 economies:

1. Starting a Business

2. Dealing with Construction Permits

3. Getting Electricity

4. Registering Property

5. Getting Credit

6. Protecting Minority Investors

7. Paying Taxes

8. Trading Across Borders

9. Enforcing Contracts

10. Resolving Insolvency

• These indicators help create an overall ranking that reflects how conducive the regulatory
environment is to starting and running businesses.

3. Benefits of the Ease of Doing Business Ranking

• Economic Development: A strong private sector is essential for a country’s economic growth.
EoDB rankings provide a tool to gauge how easily businesses can be established, operated, and
expanded.

• Foreign Direct Investment (FDI): Higher EoDB rankings can attract more FDI, as businesses tend
to invest in countries with easier business regulations.
• Job Creation and Standard of Living: A favorable EoDB environment enables businesses to grow,
contributing to job creation and improving the population's standard of living.

• Improved Government and Business Relations: EoDB rankings highlight the importance of
government policies in fostering a conducive business environment and demonstrate the
interdependence between government actions and business success.

4. Effectiveness of EoDB Rankings

• Global Recognition: Countries with a higher EoDB ranking enjoy a better global reputation,
which encourages foreign investments.

• Better Regulatory Environment: A higher ranking suggests that the country’s regulatory
environment is supportive of business operations, simplifying processes like registration,
permits, and access to credit.

• Foreign Investment Attraction: A favorable EoDB ranking often leads to increased foreign
investment, as companies seek countries where the business environment is more transparent
and predictable.

5. Reasons for the Discontinuation of EoDB Rankings

• Credibility Issues: Over time, the EoDB rankings faced growing credibility concerns. Critics
questioned the accuracy and fairness of the data used to rank economies.

• Politicization of Rankings: The ranking system was criticized for being politicized, with some
arguing that certain countries were artificially boosted or downplayed based on geopolitical
interests.

• Methodological Flaws: The methodology used to calculate rankings had several shortcomings:

o Paperwork Issues: The process to rank countries often focused on formalities like
notarization and bureaucratic processes, which might not reflect the true ease of doing
business.

o Failure to Capture Unorganised Sector: The rankings did not account for the large
unorganised sector, which is significant in many economies and directly impacts the cost
of doing business.

o Focus on Large Firms: Small and medium-sized businesses, as well as partnership and
proprietary firms, were often excluded from the rankings, which did not provide a full
picture of the business environment.

o Impact of COVID-19: The global COVID-19 pandemic further exposed the limitations of
the ranking system, as businesses increasingly moved online and mobile, complicating
the assessment of regulatory ease.

6. Conclusion

The Ease of Doing Business Index played a critical role in helping governments and businesses
understand the ease of conducting business across the globe. While it provided significant
 insights into the regulatory environment, its discontinuation was driven by various
methodological, political, and practical issues. Despite its discontinuation, the need for
transparent and effective regulatory frameworks for business growth remains a priority for
economies aiming to attract investment and improve their business climate.

India and the Ease of Doing Business (EoDB)

1. India’s Performance in the EoDB Index

• 2020 Ranking: According to the World Bank Report, India ranked 63rd out of 190 nations in the
Ease of Doing Business (EoDB) in 2020.

• Improvement Over Time: India’s EoDB ranking improved dramatically from 142nd in 2014 to
63rd in 2020, moving up 79 places in just five years. This shift was the result of comprehensive
regulatory reforms initiated by the Indian government.

2. Government Initiatives and Reforms

• 2014 Reform Agenda: The Indian government launched a series of regulatory reforms in 2014
aimed at facilitating business operations and improving the ease of doing business in the
country.

• Focus Areas of Reform: The reforms primarily focused on simplifying processes and reducing the
time and costs involved in starting and running a business.

3. Key Accomplishments in India’s EoDB Journey

• Construction Permits: India’s ranking in obtaining construction permits rose from 184th in 2014
to 27th in 2019. This improvement is attributed to a reduction in the steps and time required to
obtain construction licenses.

• Getting Electricity: India’s ranking for getting electricity improved significantly, rising from 137th
in 2014 to 22nd in 2019. The country streamlined the process, reducing it to four steps and 53
days to secure a power connection.

• Credit and Minority Investor Protection: India also ranked 25th in getting credit and 13th in
protecting minority investors, reflecting improvements in financial transparency and investor
protections.

4. Corporate Governance Reforms

• SEBI's Role: The Securities and Exchange Board of India (SEBI) has been proactive in improving
corporate governance for listed companies. Amendments to Listing Regulations have aimed to
ensure greater transparency and accountability in corporate operations.

• Regulation of Unlisted Companies: The Ministry of Corporate Affairs (MCA) regulates corporate
governance for unlisted companies, and the Companies Act is the primary law governing
corporate behavior. For certain companies, specific regulators enforce additional sectoral
governance requirements.
• Risk Management Committee (RMC): SEBI mandated the formation of Risk Management
Committees (RMCs) for prescribed classes of companies, ensuring better risk identification and
management.

• Cooling Off Period for Independent Directors (IDs): SEBI has introduced a cooling off period for
Independent Directors (IDs) after their term ends, preventing them from taking managerial
positions in the same company or its group companies for a specified period.

5. Moving Towards Digitalisation and Ease of Compliance

• COVID-19 and Digital Transformation: The pandemic accelerated the shift toward digitalisation.
Many temporary relaxations, such as virtual meetings and electronic document submission, have
now become permanent or are in the process of being institutionalized.

• Investor-Friendly Measures: The government introduced investor-friendly initiatives like

enabling companies to send documents to investors electronically, with physical documents
sent only if requested by the investor.

• Virtual Meetings and AGM Flexibility: Companies are allowed to conduct Annual General
Meetings (AGMs) and Extraordinary General Meetings (EGMs) through physical, virtual, or
hybrid modes, offering more flexibility in compliance.

• Digitising Company Records: To reduce compliance costs, companies are now required to
maintain electronic registers on consolidated platforms, easing access for stakeholders and
improving transparency.

6. Decriminalization and the Companies (Amendment) Act, 2019

• Committee Review: The Ministry of Corporate Affairs (MCA) established a committee in 2018
under the chairmanship of Mr. Injeti Srinivas to review compoundable and non-compoundable
offences under the Companies Act and recommend a re-categorization of offences.

• Recommendations for Decriminalization: The committee suggested re-categorizing 16 out of 81

compoundable offences under the Act, moving them to an in-house adjudication framework
for penalty enforcement.

• Institution of Technology-Driven Adjudication: The committee proposed the establishment of a

transparent, technology-driven adjudication mechanism, which would enable online
proceedings and digital publication of orders, reducing physical interaction and improving
efficiency.

• Regional Director's Role: The MCA suggested enhancing the jurisdiction of the Regional Director
to compound offences up to ₹25,00,000, helping to reduce the burden on the National
Company Law Tribunal (NCLT).

• Companies (Amendment) Act, 2019: The committee’s recommendations were formalized in the
Companies (Amendment) Act, 2019, which aimed to simplify compliance, improve corporate
governance, and promote ease of doing business by reducing procedural complexities.

7. Conclusion
 • India’s Progress: India has made significant strides in improving its business environment,
evidenced by its remarkable rise in the EoDB rankings. Reforms in areas like construction
permits, electricity access, and credit systems have contributed to a more conducive
environment for business.

• Ongoing Reforms: The government's continued focus on digitalisation, corporate governance,

and decriminalization under the Companies Act will further enhance India’s attractiveness as a
global investment destination.

• Future Outlook: India’s business reforms are positioning the country to be a key player in the
global economy, offering businesses a more efficient, transparent, and investor-friendly
environment.

Categories of Offences Under the Companies Act, 2013

1. Offences Attracting Only Civil Liabilities (Penalties)

• Section 454: Under this provision, the Central Government may appoint officers (not below the
rank of Registrar) as adjudicating officers to impose penalties on companies for defaults. The
power of these officers includes levying penalties and directing the company to rectify defaults.

• Nature of Offences: The Committee recommended that only procedural or technical offences—
where the public interest is not significantly impacted—should fall under this in-house
adjudication mechanism.

• Examples of Offences: Some of the offences that have been re-categorized to be subject to civil
liability include:

o Issuance of shares at a discount

o Failure to file annual returns

• Current Situation: There are now 34 instances under the Companies Act that are subject to civil
penalties for non-compliance.

2. Compoundable Offences

• Section 441: This section defines offences that are compoundable, i.e., they can be settled by
paying a penalty rather than facing imprisonment.

• Jurisdiction for Compounding: Compoundable offences can be compounded either by the

National Company Law Tribunal (NCLT) or the Regional Director, depending on the maximum
fine that can be imposed.

• Regional Director’s Expanded Jurisdiction: To reduce the burden on the NCLT, the Regional
Director’s jurisdiction for compounding offences was increased from ₹5,00,000 to ₹25,00,000.

• Offences that Maintain Status Quo: Some compoundable offences will not be included in the in-
house adjudication mechanism, including:
 o Non-compliance with statutory orders

o Offences that affect the rights and liabilities of members

o Offences related to critical disclosures that impact the company’s records.

3. Non-Compoundable Offences

• Definition and Scope: These are offences typically involving more serious matters, such as fraud,
and are punishable by imprisonment or both imprisonment and a fine.

• Fraud Offences: Under Section 447, fraud is defined and carries stringent punishments. While
some fraud-related offences have become compoundable under the Companies (Amendment)
Act, 2017, those that involve significant public interest remain non-compoundable.

• Core Principle: The Committee emphasized that serious and grave offences, especially those
involving fraud or significant harm, must have strong deterrence measures, including
imprisonment.

De-Criminalization of CSR Violations

• Initial Criminalization: Under the Companies (Amendment) Act, 2019, corporate social
responsibility (CSR) violations were criminalized, with penalties under Sections 135(6) and
135(7). Section 135(6) mandates companies to transfer unspent CSR funds to a specified fund,
and Section 135(7) imposes penalties on the company and its officers for failure to comply.

• Industry Backlash: The criminalization of CSR violations received significant criticism from the
corporate sector, with concerns that this was inconsistent with the voluntary nature of CSR
initiatives.

• Policy Revision: On August 24, 2019, responding to industry concerns and the recommendations
of the High Level Committee on CSR chaired by Mr. Injeti Srinivas, the Ministry of Corporate
Affairs (MCA) decided to treat CSR violations as civil liabilities rather than criminal offences.

• Committee's Recommendation: The High-Level Committee concluded that CSR provisions

should align with the spirit of partnership for social development and should not be penal in
nature. Consequently, the MCA has committed to reviewing CSR provisions under the Companies
Act.

Summary of Key Changes

• In-house adjudication mechanisms have been introduced for minor procedural defaults (e.g.,
failure to file annual returns, issuance of shares at a discount).

• Compoundable offences can now be handled by the Regional Director, easing the workload of
the NCLT.

• Non-compoundable offences, especially those involving fraud, will continue to attract strong
penalties, including imprisonment.
 • CSR violations were initially criminalized but have now been reverted to civil liabilities following
corporate feedback and committee recommendations.

These reforms aim to streamline compliance, improve the ease of doing business, and ensure that
penalties are proportional to the nature of the offence committed under the Companies Act, 2013.

4o mini