Union Budget 2019-20: Impact on Corporate and Financial sector

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RBI to strengthen corporate governance for Core Investment Companies.

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Vinod Kothari

As a part of the Bi-monthly Monetary Policy on 6th June, 2019, the RBI’s review of Development and Regulatory Policies [https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=47226] proposed to set up a working group to strengthen the regulatory framework for core investment companies (CICs). The RBI states: “Over the years, corporate group structures have become more complex involving multiple layering and leveraging, which has led to greater inter-connectedness to the financial system through their access to public funds. Further, in light of recent developments, there is a need to strengthen the corporate governance framework of CICs. Accordingly, it has been decided to set up a Working Group to review the regulatory guidelines and supervisory framework applicable to CICs.”

Core investment companies are group holding vehicles, which hold equities of operating or financial companies in a business group. These companies also give financial support in form of loans to group companies. However, CICs are barred from dealing with companies outside the group or engaging in any other business operation.

Currently as per the data as on 30th April, 2019, there are only 58 registered CICs in the country. There may be some unregistered CICs as well, since those not having “public funds” do not require registration.

If a CIC is not holding “public funds” (a broad term that includes bank loans, inter-corporate deposits, NCDs, CP, etc.), the CIC is exempt from registration requirement. Presumably such CICs are also excluded from any regulatory sanctions of the RBI as well. However, it is quite common for CICs to access bank loans or have other forms of debt for funding their investments. Such CICs require registration and come under the regulatory framework of the RBI, if their assets are worth Rs 100 crores or more.

Corporate governance norms applicable to systemically important NBFCs are currently not applicable to CICs.

The RBI has observed that CICs are engaged in layering of leverage. This observation is correct, as very often, banks and other lenders might have lent to CICs. The CICs, with borrowed money, use the same for infusing capital at the operating level below, which, once again, becomes the basis for leveraging. Thus, leveraged funds become basis for leverage, thereby creating multiple layers of leverage.

While agreeing with the contention of the RBI, one would like to mention that currently, the regulatory definition of CICs is so stringent that many of the group holding companies qualify as “investment companies” (now, credit and investment companies) and not CICs. There is a need to reduce the qualifying criteria for definition of CICs to 50% of investments in equities of group companies. This would ensure that a large number of “investment companies” will qualify as CICs, based on predominance of their investments, and would be viewed and regulated as such.

Prominent among the registered CICs are entities like Tata Sons, L&T Finance Holdings, JSW Investments, etc. The extension of corporate governance norms to CICs is unlikely to benefit any, but impact all.

The Reserve Bank has accordingly constituted the Working Group to Review Regulatory and Supervisory Framework for Core Investment Companies on 3rd July, 2019 [https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR43DDEE37027375423E989F2C08B3491F4F.PDF]. The Terms of Reference (ToR) of the Working Group are given below:

  • To examine the current regulatory framework for CICs in terms of adequacy, efficacy and effectiveness of every component thereof and suggest changes therein.
  • To assess the appropriateness of and suggest changes to the current approach of the Reserve Bank of India towards registration of CICs including the practice of multiple CICs being allowed within a group.
  • To suggest measures to strengthen corporate governance and disclosure requirements for CICs
  • To assess the adequacy of supervisory returns submitted by CICs and suggest changes therein
  • To suggest appropriate measures to enhance RBI’s off-sight surveillance and on-site supervision over CICs.
  • Any other matter incidental to the above.

As per the press release, the Working Group shall submit its report by October 31, 2019.

MCA set to deploy the eForm for reporting details of SBOs

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Ambika Mehrotra

corplaw@vinodkothari.com

Background

Amendment to Section 89 and insertion of Section 90 are one of the key amendments brought in by the Companies (Amendment) Act, 2017 (‘Amendment Act’).  The said provisions were enforced w.e.f. June 14, 2018and Companies (Significant Beneficial Owners) Rules, 2018 were notified[1] (‘SBO Rules’). MCA, thereafter, issued General Circular No 7/ 2018[2]for extending the last date of filing eForm BEN-2 and 08/ 2018[3] to the effect that the format of declaration to be submitted by Significant Beneficial Owner (SBO) will undergo revision.

MCA on February 8, 2019[4] amended SBO Rules by amending the definition of significant beneficial owner. The due date for submission of declaration in Form BEN-1 was 90 days from the said amendment. However, eForm for filing the said declaration with MCA was not made available.

MCA, on July 1, 2019, issued Companies (Significant Beneficial Owners) Second Amendment Rules, 2019[5]thereby notifying eForm BEN-2 required to be submitted by companies.

Scope of Section 90

Section 90 focuses on the identification of a ‘significant beneficial owner’ through his ‘indirect holdings’ in an entity, which is to be considered only where the individual has majority interest in the vehicle holding stake in the “reporting company”, or in the ultimate holding entity of such holding vehicle. That is to say, simply direct holding or direct control, or direct significant influence (without any indirect holdings) were not required to be reported as significant beneficial interest under the Rules, irrespective of the magnitude of direct holding. Therefore, the direct holding of interest by an individual is relevant only if the direct holding may be clubbed with indirect holding.

Onus of making the declaration

The individual holding significant beneficial interest by virtue of holding shares or voting rights or right to distributable dividend or exercising significant influence was required to furnish the declaration in Form No. BEN-1 within 90 days of February 8, 2019 and thereafter in case of any change, to the reporting company. Herein, the onus lies on the individual to come forward and submit the declaration. The reporting companies on the other hand were required to give notice to members (other than individual) holding 10% or more of participating interest [either of shares, voting rights, or right to receive or participate in the dividend or any other distribution],  seeking information about the individual who is significant beneficial owner in the reporting company in Form BEN-4.

It is pertinent to note that the obligation of the individual to self-declare his significant beneficial holdings and the obligation of the company to send notice seeking information from members in terms of Rule 2Aare independent obligations.

Intimation to the ROC by the reporting entity

As per the SBO Rules as amended from time to time, the declaration of beneficial interest is required to be filed in e- Form BEN-2 with the Registrar in respect of such declaration, within a period of thirty days from the date of receipt of declaration by the company.

With the deployment of e-Form BEN -2 vide Companies (Significant Beneficial Owners) Second Amendment Rules, 2019, the Companies shall be required to intimate the same to the Registrar within 30 days of its deployment.

Companies are facing difficulty in identification of SBO in view of complex structures. Until receipt of declaration in Form BEN-1, companies will not be able to file eForm BEN-2.

Consequences of non-filing

Section 90(11) of the Act, 2013 provides for penal provisions for the failure of the part of the company and every officer in default in complying with the provisions of Section 90(4) i.e. filing of the above return  and changes therein with the Registrar with a fine:-

  • For company and every officer in default:- Rs. 10 Lakhs – Rs. 50 Lakhs
  • For Continuing default: – Upto Rs. 1000 for every day after first day of failure.

Analysis of e-Form BEN -2

  • Declaration of holding reporting company

 Pursuant to Rule 8 of the SBO Rules, which states that the rules are not applicable to the extent the shares of the reporting company is held by its holding reporting company. It is presumed that the SBO of the holding company is also the SBO of the subsidiary company for the shares held by the holding company.

First bullet of Field no. 3 requires the companies to report the details of such holding reporting company which shall be mapped through the CIN of such company.

  • Requirement to furnish copy of agreement

 In order to specify the manner in which significant beneficial interest is being held or exercised either indirectly or together with any direct holding or right, the form requires attachment of agreement in following cases:

  1. Exercise of control
  2. Exercise of significant influence

 This might be a serious constraint, as it may not be necessary that the companies might have in place a written and executed agreement specifying the control and/ or significant influence exercised by the members. However, at present the mode of mapping of control and/ or significant influence has only been done through the agreement to be attached in the form.

Conclusion

While, the eForm BEN-2 seems a derivative of the format of declaration Form BEN no. 1, companies will be able to report correctly subject to receipt of accurate declarations from the SBOs.

Other practical difficulties in reporting in the eForm can be ascertained once the eForm is deployed on MCA portal.

 

Other related articles on SBO can viewed here-

http://vinodkothari.com/2019/02/mca-revisits-sbo-rule/

http://vinodkothari.com/wp-content/uploads/2019/03/Final-FAQs-on-revised-SBO-Rules_17.03.2019-1.pdf

http://vinodkothari.com/wp-content/uploads/2019/03/Guide-to-identification-of-SBO-in-your-Company.pdf

http://vinodkothari.com/2019/02/new-sbo-rules-illustrations/

http://vinodkothari.com/wp-content/uploads/2019/02/Amended-SBO-Rules.pdf

 

[1]http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantBeneficial1306_14062018.pdf

[2]http://www.mca.gov.in/Ministry/pdf/GeneralCircularNo.7_06082018.pdf

[3]http://www.mca.gov.in/Ministry/pdf/GCCircularBen_10092018.pdf

[4]http://www.mca.gov.in/Ministry/pdf/CompaniesOwnersAmendmentRules_08020219.pdf

[5]http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantRules_01072019.pdf

 

Shareholder’s resolution for debt issues: Whether approval under Sec 180(1)(c) suffices?

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Core competencies of Directors: the new disclosure requirement for listed entities

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By Munmi Phukon

Principal Manager, Vinod Kothari & Company

munmi@vinodkothari.com

Introduction

How does a person get into the board of directors of a listed entity? Simply because he happens to be a majority shareholder, or the son of the promoter, or a morning-walk friend of the promoter? Or, is it that a listed company is expecting supervisory leadership to come from a body consisting of individuals with diverse skills and competencies? What are those key competences and skill sets required from directors, and which of the company’s directors possess which of these abilities? These are questions that listed entities and their stakeholders might have either not put before themselves, or even if considered, may not have had structured answers to these questions. However, come this year, every listed entity shall give a list of core skills/ expertise/ competencies of the Board members, and come next year, the names of the directors who actually possess such skills/ expertise/ competencies.

In the above para, one is referring to a new provision under Para C of Schedule V pertaining to the contents of corporate governance report which reads as follows:

“C. Corporate Governance Report: The following disclosures shall be made in the section on the corporate governance of the annual report.

XXX

(h) A chart or a matrix setting out the skills/expertise/competence of the board of directors specifying the following:

(i) With effect from the financial year ending March 31, 2019, the list of core skills/expertise/competencies identified by the board of directors as required in the context of its business(es) and sector(s) for it to function effectively and those actually available with the board; and

(ii) With effect from the financial year ended March 31, 2020, the names of directors who have such skills / expertise / competence.”

Importance & objectives of having a diverse Board

The importance of a diverse and skilled Board is recognised around the world. It is more than a necessity considering the complex and dynamic business environment. The Board is the set of leaders who provide comprehensive guidance, support and direction to the company towards its success. The objective of having skilled Board is manifold considering the involvement of public money, be it of the public shareholders, lenders or other creditors. Stakeholders are concerned about the attitude of the firm towards corporate governance as a diverse set of individuals collectively known as Board cannot take a casual approach on the management of the firm sitting on the pile of public money. Therefore, it is always required for the NRC to have a clear view as to what is being expected from the directors, what would be the set of skills, competencies, expertise, knowledge etc. that would be possessed by the directors, whether the same is broad based and also, to ensure an effective evaluation mechanism.

What does law require?

Till the amendments in the Listing Regulations coming into force, Regulation 36 required disclosure of the nature of the expertise in specific functional areas of a proposed appointee including a person seeking re-appointment to the shareholders. Further, Rule 5 of the Companies (Appointment and Qualification of Directors) Rules provided the qualification of the independent directors as persons who shall possess appropriate skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.

The new requirement of disclosure has been framed based on the Kotak Committee Recommendations whose rationale was primarily based on the fact that the existing requirement of law was not sufficient to the shareholders for their adequate analysis whether the Board of the company has sufficient mix of diverse expertise/ skill- sets.

The broad parameters[1]

The Board is responsible for shaping the future of the organisation within its fiduciary characteristics. Therefore, identifying the key competencies of the Board members is very much essential to ensure that the qualified persons undertake this cardinal role. Globally, identifying the key competencies of Board members is considered as the step towards a successful Board. Broadly, the parameters for identifying key competencies or skill- set can be categorised as follows:

Industry knowledge/ experience

Having experience in and knowledge of the industry in which the organisation operates is one of the key competencies of a Board member. This is required for achieving the objectives of the organisation while operating effectively, responsibly, legally and sustainably. The Board members are required to demonstrate an understanding of-

  • the relevant laws, rules, regulation policies applicable to the organisation/ industry/ sector and level/ status of compliances thereof by the organisation
  • the best corporate governance practices, relevant governance codes, governance structure, processes and practices followed by the organisation
  • business ethics, ethical policies, codes and practices of the organisation
  • the structures and systems which enable the organisation to effectively identify, asses and manage risks and crises
  • international practice

Technical skills/ experience       

To assist with the ongoing aspects of Board’s role, the members are required to possess technical/ professional skills and specialist knowledge. The directors need to be able to obtain, analyse, interpret and use information effectively to develop plans and take appropriate decisions. In order to assess possession of such skills, the person will be required to have knowledge about-

  • how to interpret financial statements and accounts in order to assess the financial health of an organisation
  • the sources of finance available to an organisation and their related merits and risks
  • how to assess the financial value of an organisation and potential business opportunities
  • importance of information technology in the organisation
  • marketing or other specific skills required for the effective performance of the organisation

Behavioural competencies/ personal attributes

Displaying high standards of conduct, ability to take responsibility for their own performance etc. are some of the behavioural competencies which the directors are required to possess. Interpersonal skills such as good communication skills, relationship building capacity etc. will come under this category. In brief, the following will be sub- sets under this head-

  • Integrity and ethical standards
  • Mentoring abilities
  • Interpersonal relations
  • Managing people and achieving change
  • Curiosity and courage
  • Genuine interest
  • Instinct
  • Active contribution

Strategic expertise 

To create and implement effective strategies, a thorough knowledge of the strategic process is required. The ability to think strategically enables directors to propose ideas, options and plans that take advantage of available opportunities while reflecting a broad and future-oriented perspective. Having an understanding of the need for a clear vision and purpose to guide the strategy, models and methods of strategic analysis, option analysis the factors involved in successful strategy implementation by the directors is required for giving a strategic direction to the organisation. The sub- sets under this head may be as below:

  • Strategic thinking
  • Vision and value creation
  • Strategy Development
  • Strategy implementation and change

Mind- set or attitude

An ethical mind- set demonstrates a high standards of conduct. Further, professional attitude and independent mind- set enables director to provide the challenge and rigour required to help the Board achieve a comprehensive understanding of information and options, as well as high standards of decision-making. The head may be segregated into the following:

  • Ethical
  • Professional
  • Performance oriented
  • Independent
  • Aware of self and others

Other skills

Other skills may include decision making, communication, leadership, influencing, risk oversight, risk management, stakeholder relations etc. Good decision-making skills is required in order to arrive at a course of action in a timely manner that provides a clear direction and moves the organisation forward. Similarly, strong leadership skills enable directors to solve problems, cope up with the crises and change, and inspire others to follow them in pursuit of the values and goals of the organisation. The ability to build good networks and relationships within and beyond the organisation is important for the director to gain influence, have impact and progress organisational goals. The ability to communicate effectively through a variety of modes and channels and with a range of audiences is necessary for directors to work successfully with others and to fulfil their duties on the Board. Directors need to understand how to deliver effective leadership, build good stakeholder relations and develop a strategically aligned and values-based organisational culture in order to achieve good organisational performance. Therefore, the sub- sets hereunder may be-

  • decision making skills
  • communication skills
  • leadership skills
  • influencing
  • risk oversight
  • risk management skills
  • stakeholder relations

Suggestive format of reporting

Broad parameter Specific skills/ expertise/ competency

 

 Director 1 Director 2 Director 3
 

 

 

 

 

 

 

 

Industry knowledge & experience

 

 

 Understanding of the relevant laws, rules, regulation policies applicable to the organisation/ industry/ sector and level/ status of compliances thereof by the organisation

 

 √ √ √
Understanding of the best corporate governance practices, relevant governance codes, governance structure, processes and practices followed by the organisation

 

 √ √ √
Understanding of business ethics, ethical policies, codes and practices of the organisation

 

 √ √ √
Understanding of the structures and systems which enable the organisation to effectively identify, asses and manage risks and crises

 

 √ √ √
Understanding of international practice

 

 √ √ √

Conclusion

The amendments require listing out of the key skills/ competencies of the Board as a part of the corporate governance report for FY 18-19. From subsequent FYs, the disclosure will have to be by way of a matrix signifying the directors actually carrying such skills. It is anticipated that such a disclosure will help the shareholders to analyse the diversity of expertise/ skill – sets of the Board. This is believed that disclosure of each of the skills against the directors will make them responsible for each of the skills. Therefore, a director will not be able to escape responsibility with the shield of immunity provided by law which is circumstantial.

 

[1] Source:

  1. https://www.asaecenter.org/resources/articles/foundation/2018/defining-board-competencies
  2. https://www.iod.com/Portals/0/PDFs/IoD%20Competency%20framework.pdf?ver=2017-10-06-135816-827
  3. https://www.effectivegovernance.com.au/services/director-skills-competency-assessment/
  4. https://aicd.companydirectors.com.au/resources/director-tools/practical-tools-for-directors/board-composition/key-competencies-for-directors
  5. https://www.effectivegovernance.com.au/services/director-skills-competency-assessment/

 

ICSI Auditing standards -A guidance to the Members in Practice

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By Kanakprabha Jethani | Executive

Kanak@vinodkothari.com

Background

ICSI has recently issued four Auditing Standards[1] (‘Standards’) for the members in practice namely:

  • CSAS-1 – Auditing Standard on Audit Engagement
  • CSAS-2 – Auditing Standard on Audit Process and Documentation
  • CSAS-3 – Auditing Standard on Forming of Opinion
  • CSAS-4 – Auditing Standard on Secretarial Audit

in order to enable them to carry out the audit engagements more effectively. The first three Standards will be applicable to all kind of audit engagements and the fourth one will specifically be applicable for the Secretarial Audit under Section 204 of the Companies Act, 2013. In terms of ICSI’s own language, the Standards shall be mandatorily effective from the audit engagements accepted on or after 1st April, 2020.

Objective of the Standards

Seemingly, ICSI is seeking to promote best auditing practices, uniformity and consistency in conduct of the audits by the members in practice. These are expected to strengthen the audit process and corporate governance practices. Since, varied audit practices are being carried over by different auditors, monitoring of audit process becomes cumbersome and troublesome at the same time. These Standards are expected to harmonise the audit practices among the auditors all over the country. The objective is to streamline and enable members to effectively undertake secretarial audit and ensure compliance. It is also expected that these Standards will enhance the quality of compliance.

Applicability of Standards

These Standards shall be effective and recommendatory to be accepted by the auditors on or after 1st July 2019. However, the same shall be mandatorily applicable to the audit assignments obtained on or after 1st April 2020.

Whether these Standards are statutorily required?

In order to be statutorily applicable and binding, legal backing to the provision is required. For example, for the Secretarial Standard-1 and secretarial Standard-2 have a backing of legal provision i.e. Section 118 of the Companies Act 2013. Section 118(10) provides that every company shall observe secretarial standards with respect to general and Board meetings specified by the Institute of Company Secretaries of India. In compliance of aforesaid section, companies follow these two secretarial standards. The same is not the case for other secretarial standards issued by ICSI such as, Secretarial Standard -3 relating to Dividend or Secretarial Standard-4 relating to maintenance of registers and records and hence purely voluntary.

Likewise, the Auditing standards issued by ICSI also do not carry a legal backing as of now though the same is being brought in by ICSI with an intent to make it mandatory.

What are the various audits a PCS can undertake?

A Practising Company Secretary is authorised to undertake various audits as prescribed under the Companies Act 2013, SEBI regulations and other applicable laws, some of which are as under:

  • Secretarial Audit as per provisions of Section 204 of the Companies Act 2013;
  • Half-yearly certificate certifying that all share certificates were issued by Share transfer Agent/ Registrar and transfer Agent within 30 days of lodgement of transfer as provided under regulation 40(9) of SEBI(Listing Obligations and Disclosure Requirements) Regulations;
  • Annual Secretarial Compliance Report as per SEBI Listing Regulations;
  • Half-yearly certification of maintenance of 100% asset cover for non-convertible debt securities as per regulation 56(d) of SEBI(Listing Obligations and Disclosure Requirements) Regulations;
  • Certificate regarding compliance of conditions of corporate governance as per SEBI Listing Regulations;
  • Share Reconciliation Certificate as per SEBI (Depositories and Participants) Regulations, 2018 etc.

These Standards shall be applicable to all these audits along with any other audit required to be done by PCS. Thus, for the purposes of these Standards, ‘Auditor’ shall mean a Practising Company Secretary undertaking any of such audits.

The list of TO DO’s for auditors

CSAS-1 – AUDITING STANDARD ON AUDIT ENGAGEMENT

This deals with roles and responsibilities of Auditor undertaking audit engagement. They also elaborates procedures and principles for entering into agreement with appointing authority.

Eligibility to take audit engagement

  • Auditor shall not hold, singly or along with partners, spouse, parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, more than 2% in the paid up share capital or shares of nominal value of Rs. 50,000, whichever is lower or more than 2% voting power in the Auditee, as the case may be.
  • Auditor shall not be indebted to the Auditee for an amount of five lakh rupees or more except if such indebtedness is arising out of ordinary course of business.
  • If an Auditor was in employment of the Auditee, its holding or subsidiary company and 2 (two) years must have lapsed from the date of cessation of employment.

Things to do pursuant to CSAS-1:

  • Ensure that appointment is made as per provisions of Companies Act 2013 and rules made thereunder.
  • Submit eligibility certificate to appointing authority.
  • Obtain audit engagement letter and copy of resolution passed by appointing authority and provide acceptance thereto.
  • Ensure audit engagement letter includes:
  1. The objective and scope of the audit; if the same has been established by law, reference to relevant provisions must be stated.
  2. The responsibilities of the Auditor and the Auditee;
  3. Written representations provided and/or to be provided by the Management to the Auditor, including particulars of the Predecessor or Previous Auditor;
  4. The period within which the audit report shall be submitted by the Auditor, along with milestones, if any;
  5. The commercial terms regarding audit fees and reimbursement of out of pocket expenses in connection with the audit;
  6. Limitations of audit, if any.
  • Intimate previous auditor about such engagement, in writing.
  • Ensure that such engagement is within the limits prescribed by ICSI from time to time.
  • Maintain confidentiality of information obtained during the course of audit unless there is a legal obligation to disclose such information. Also, ensure that employees, staff and other team members also be bound by duty of confidentiality.
  • Do not agree to change in terms of engagement unless there is reasonable justification for doing so.
  • If terms of appointment are changed resulting in lower level of assurance, it shall be accepted only after considering the appropriateness of the same.
  • Any changes in terms of engagement must be agreed by way of supplementary or revised engagement letter.

 

CSAS-2 AUDITING STANDARD ON AUDIT PROCESS AND DOCUMENTATION

This Standard deals with the roles and responsibilities of Auditor with respect to maintenance of proper audit records that provides-

  • sufficient and appropriate record to form the basis for the Auditor’s Report; and
  • evidence that the audit was planned and performed in accordance with the applicable Auditing Standards and statutory requirements.

Things to do pursuant to CSAS-2

  • Formulate an audit plan as per terms of audit engagement.
  • Ensure adherence to audit plan.
  • Conduct risk assessment of auditee considering business, environmental and organisational structure and compliance requirements.
  • Evaluate high-risk areas relating to internal control systems, transparency, prudence, probity, changes in compliance team etc.
  • Obtain sufficient information of the auditee for conduct of audit.
  • Make use of systematic and comprehensive checklists.
  • Obtain necessary evidence and evaluate the same so as to support the opinion. This shall be adequately documented in audit working papers.
  • Obtain third-party confirmations wherever required.
  • Document discussions with management of the auditee in significant matters.
  • Collate the documentation for records within 45 days of date of signing of auditor’s report.
  • Maintain documentation in physical or electronic form for a period of 8 years from date of signing of auditor’s report.

Features of audit plan

  • The audit shall be planned in a manner which ensures that qualitative audit is carried out in an efficient, effective and timely manner.
  • Audit planning shall ensure that appropriate attention is accorded to crucial areas of audit and significant issues are identified in a timely manner.
  • Audit plan should be based on professional scepticism, so that it is possible to exercise professional judgment in an objective manner.

CSAS-3 – Auditing Standard on Forming of Opinion

This Standard provides details about the manner of evaluation of conclusions derived out of audit evidence which leads to formation of Auditor’s opinion.

Things to do pursuant to CSAS-3

  • Consider materiality while forming opinion.
  • Consider all relevant audit evidence before issuing audit report.
  • Apply professional judgement and scepticism to ensure evidence is factually correct.
  • Prepare audit report within the agreed time-frame.
  • Verify accuracy of facts and responses from concerned persons.
  • Adhere to generally accepted principles and practices in relation to audit process.
  • Indicate if any third-party report or opinion is being relied on.
  • Indicate if third-party report is provided by the auditee and also consider important findings of third party.
  • Carry out a supplemental test to check veracity of third-party report.
  • Express unmodified opinion if satisfied that applicable laws have been duly complied with and relevant records are free from misstatement.
  • Express modified opinion in bold or italic letters. Modified opinion is to be issued if:
    • non-compliance of applicable laws is found,
    • relevant records aren’t free from misstatement,
    • sufficient and appropriate audit evidence to ensure the above is not available.

 

 

  • Ask auditee to remove any such limitation on scope of audit which is likely to make the Auditor give modified opinion or disclaimer.
  • Give unmodified opinion, if in case of absence of sufficient and appropriate evidence, Auditor can conclude that effects of unavailability of such evidence will be non-material. However, if the effects are likely to be material, the auditor shall express disclaimer of opinion.

Format of audit report

  • The report shall be addressed to appointing authority unless the terms of engagement provide otherwise.
  • Report must be detailed. Specific formats, if any, must be followed.
  • Provide annexures for detailing of certain aspects, wherever necessary.
  • Include a section named Auditor’s responsibility in the audit report.
  • This section shall state that the audit was conducted in accordance with applicable Standards.
  • The report shall state that due to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements or material non-compliances may not be detected, even though the audit is properly planned and performed.
  • Signature block shall mention name of auditor/firm, certificate of practice number/registration number and membership number of the auditor.
  • Mention clearly the date and place of signing audit report.

CSAS-4 – Auditing Standard on Secretarial Audit

This Standard lays down the manner of evaluation of statutory compliances and corporate conduct in the process of doing secretarial audit u/s 204 of the Companies Act, 2013. It gives a broad structure to the audit process.

Things to do pursuant to CSAS-4

  • Take note of laws applicable to the auditee. This includes specific laws as well as general laws.
  • Review Memorandum of Association, Articles of Association, statutory books, disclosure by the auditee etc.
  • Identify events and corporate actions that took place in the audit period by reviewing website of the auditee, disclosures made to stock exchanges, statutory records of the auditee etc.
  • Verify event based as well as calendar compliances of the auditee.
  • Verify composition of Board of directors is in compliance with applicable rules and regulations i.e. optimum combination and strength is maintained and directors are not disqualified.
  • Ensure formation of required committees and proper composition of such committees.
  • Ensure decisions by board of directors are taken in compliance with the law i.e. in properly constituted meeting or by circulation.
  • Ensure that systems of compliance are adequate and effective.
  • Analyse instances of receipt of show cause notices, prosecutions initiated, fee or penalty levied etc.
  • Collect further evidence and conduct in-depth checking if a fraud is suspected.
  • If there is a sufficient reason to believe that a fraud has been committed, the same shall be reported to Audit Committee/Board/Central Government as per the process laid down under the Companies Act, 2013. Also, the same shall be included in Secretarial Audit Report.
  • Verify the comments received on reporting fraud.
  • Include fraud detected by other auditor in the audit report.
  • Report all the events that affect auditee’s going concern or alters the charter or capital structure or management or business operation or control, etc.

Conclusion

These Standards provide a broad structure to the audit process and direction as to proceeding the audit. Having a direction to proceed will make the audit more systematic. To establish these structures and systems would initially require plenty of clerical nature work. However, this is a one-time labour to be put in for structuring all the future audits.

These Standards are issued with a motive to enhance the level and quality of compliance and at the same time harmonise the audit practices being followed by various auditors. Unity of procedures ensures clarity to the auditee which enables them to ensure systematic compliance. Application of these Standards is believed to be beneficial for the Auditors as well as the companies and regulators in the long run.

[1] https://www.icsi.edu/media/webmodules/ICSI_Auditing_Standards.pdf

Need for permanent chairperson – post in listed companies: an analysis

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by Smriti Wadehra (smriti@vinodkothari.com)

Introduction

Corporate governance standards world-over have highlighted the role of the chairperson in corporate boards of listed entities. There has also been a move recently as to separation of the role of the CEO and the chairperson, such that the person who is executive head of the company (CEO) is also not its supervisory head (chairperson). However, what exactly is the function of the chairperson in Indian laws? Is the chairperson merely the convenor of board and general meetings, or does he/she have a role beyond meetings? In light of the answer to this question – a significant question is, is it necessary for a listed entity to have a permanent board chairperson, or can the chairperson be appointed for each meeting? We have tried to answer this question in the context of Indian and global laws.

Unless otherwise provided in the Articles of Association of the Company, the Companies Act, 2013 (‘CA, 2013’) and Listing Regulations, 2015 do not explicitly lay down provisions mandating the appointment/election of a permanent Chairperson of the Board. However, section 104 of the CA, 2013 provides that either the Chairperson of the Board, or the one of the directors or one of the directors, as the case may be shall act or be elected as the Chairperson of a general meeting. In view of the same, having a permanent chairman is not mandatory, however, having a chairman for board and general meeting is mandatory.

The word “Chairman” is used very loosely in general parlance, however, chairman of companies are of different types depending upon their requirement. Therefore, in order to understand the importance of chairperson in a Company, we have to first understand the reason of appointing chairman and capacities a chairman holds in a Company. Generally, a chairman may be:

a) Chairman of Board;

b) Chairman of General Meeting;

c) Chairman of Company and;

d) Chairman of Committees;

In most of the cases, they are the same, however, they have a thin line of difference between each one of them which has been discussed in a detailed manner below:

Chairman of Board

Usually, the Chairman of the company becomes the Chairman of the Board. However, if the company does not have a Chairman, the Directors elect one of themselves to be the Chairman of the Board and conducts the Meetings of the Board. Further, if no Chairman is elected by the Board or if the Chairman is unable to attend the Meeting, the Directors present at the Meeting shall elect one of themselves to chair and conduct the Meetings, unless otherwise provided in the Articles. Further, the board committees may elect different chairperson for its meetings. Considering the aforesaid, the listing regulations, 2015, also requires a Company to appoint Chairperson for board meeting and different chairpersons for board committees.

Therefore, on conjoint reading of the above, it can be concluded that every meeting of the Board requires a Chairman, however, the Company may not have a chairman on board. To clarify, please note that the provisions of Act suggests for having a chairman for meeting of board therefore it is the discretion of the Company they may appoint a specific individual as ‘Chairman of the Board’ or appoint randomly any director at every meeting of Board as ‘Chairman of the Meeting’. Further all the provisions of law relates to Chairman of the Board and not Chairman of the Meeting i.e. for instance as per the provisions of SS-1:

“Chairman” means the Chairman of the Board or the Chairman appointed or elected for a Meeting.”

Hence, the chairman of general meeting can be either chairman of board or any member as may be selected by members themselves during the meeting.

Further, the Listing Regulations refers to having a Chairperson with respect to examining the composition of the board and appointment of requisite number of IDs in order to have proper composition as:

“17(1)(b) where the chairperson of the board of directors is a non-executive director, at least one-third of the board of directors shall comprise of independent directors and where the listed entity does not have a regular non-executive chairperson, at least half of the board of directors shall comprise of independent directors”

In this case, the composition of the Board is dependent on the designation of the chairman of the board, however, the same shall be applicable only when the Company has a permanent chairman on the board. Accordingly, if the company has a practice of appointing a chairman at the respective board meetings, the condition of the said regulation shall not apply.

Chairman of General Meeting

As per the provisions of Secretarial Standard 2 on General Meetings issued by ICSI provides:

“Chairman” means the Chairman of the Board or the Chairman appointed or elected for a Meeting.”

As per the SS-2 the Chairman of the Board shall take the Chair and conduct the General Meeting. However, in case the Chairman is not present within fifteen minutes after the time appointed for holding the Meeting, or if he is unwilling to act as Chairman of the Meeting, or if no Director has been so designated, the Directors present at the Meeting shall elect one of themselves to be the Chairman of the Meeting. Further, if no Director is willing to take the Chair, the Members present shall elect, on a show of hands, one of themselves to be the Chairman of the Meeting.

Further, the provisions of Section 104 of the Companies Act, 2013 provides:

“Unless the articles of the company otherwise provide, the members personally present at the meeting shall elect one of themselves to be the Chairman thereof on a show of hands.”

Therefore, this suggests that the chairman of the Board appointed as per the Articles of the Company, may chair the meeting of shareholders. However, in case the Company does not have a chairman on board the members present may elect one of themselves as Chairman for that specific meeting.

Accordingly, one may conclude that having a Chairperson on the Board is required considering the role and responsibility and election of a Chairperson of general meeting is a mandatory as per law.

Chairman of the Company

Referring to our aforesaid discussion, we may say that appointment of permanent chairman is a discretionary power of companies, usually exercised to avoid inconvenience of appointing new chairman for the board and general meetings, respectively.

Chairman of Committees

A member of the Committee appointed by the Board or elected by the Committee acts as Chairman of the Committee, in accordance with the Act or any other law or the Articles, who shall conduct the Meetings of the Committee. However, if no Chairman has been so elected or if the elected Chairman is unable to attend the Meeting, the Committee shall elect one of its members present to chair and conduct the Meeting of the Committee, unless otherwise provided in the Articles.

Further, if no such Chairperson is elected, or if at any meeting the Chairperson is not present within five minutes after the time appointed for holding the meeting, the members present may choose one of their members to be Chairperson of the meeting.

The Listing Regulations specifically provides the eligibility for appointment of chairman in specific committees as appended below:

  • Audit Committee:

“18(1)(d) The chairperson of the audit committee shall be an independent director and he shall be present at Annual general meeting to answer shareholder queries.

  • Nomination and Remuneration Committee

19(2) The Chairperson of the nomination and remuneration committee shall be an independent director:

 Provided that the chairperson of the listed entity, whether executive or non-executive, may be appointed as a member of the Nomination and Remuneration Committee and shall not chair such Committee.

  • Stakeholders Relationship Committee

20(2) The chairperson of stakeholders relationship committee shall be a non-executive director.

  • Risk Management Committee

21(3) The Chairperson of the Risk management committee shall be a member of the board of directors and senior executives of the listed entity may be members of the committee.”

Therefore, in case of committees the regulations specifically provides the eligibility for appointment of chairman.

Who can be a Chairman?

Considering the aforesaid provisions, it is clear that designating one person as the permanent Chairman of the company is not mandatory. However, the same needs to be elected in every meeting. Therefore, the company has two options:

  • Designate a person or a position as the one to be the chairperson [for ex: the company may state that the MD shall always be the chairperson of the company];
  • Appoint the chairperson in every meeting.

Separation of role of Chairman and MD

In this regard, we would also like stress upon the fact that the Act, 2013 does not specifically requires companies to appoint a chairman however Section 203 of the Act, 2013 restricts a Managing Director or CEO to be a chairman of the Company. The provisions lays down:

“Provided that an individual shall not be appointed or reappointed as the chairperson of the company, in pursuance of the articles of the company, as well as the managing director or Chief Executive Officer of the company at the same time after the date of commencement of this Act unless,—
(a) the articles of such a company provide otherwise; or
(b) the company does not carry multiple businesses:

Provided further that nothing contained in the first proviso shall apply to such class of companies engaged in multiple businesses and which has appointed one or more Chief Executive Officers for each such business as may be notified by the Central Government”

The provisions explicitly provides that the chairman of the Company cannot be the MD or the CEO considering the power and authority involved in both the spheres. Here, the Act provides that if the AoA of the Company permits so and if the Company is engaged in multiple businesses, then the companies may have the CEO and the chairman as the same individual.

On reading the provisions, we understand that the intent of law is to stress on the fact that the chairman of the Company have been entrusted with great responsibilities and powers which designating to an executive director may affect the independence of the board altogether. Further, Managing Director is a person entrusted with substantial powers of management, which makes an MD the decision maker in the Company. Therefore, designating a person a CMD in the Company may not do justice to both roles i.e. the MD may not be able to discharge his responsibilities completely as an MD or as Chairman. However, where the Company is engaged in multiple businesses with more than one MD/CEO in the Company, then in that situation the Company may rethink to designate a person as CMD.

Where the Companies Act, 2013 provided for separation of role of Chairman and CEO the provisions of SEBI (LODR) Regulations, 2015 remain silent on the topic and provided a discretionary requirement. However, the recommendations of Uday Kotak Committee on Corporate Governance clearly provided for separation of role of CEO/MD from the chairman for better governance. The relevant extract of the recommendation is provided below:

“The separation of powers of the chairperson (i.e.  the leader  of  the board)  and  CEO/MD (i.e. the leader of the management) is seen to provide a better and more balanced governance structure by enabling better and more effective supervision of the management, by virtue of:

  1. providing a structural advantage for the board to act independently;
  2. reducing excessive concentration of authority in a single individual;
  3. clarifying the respective roles of the chairperson and the CEO/MD;
  4. ensuring that board tasks are not neglected by a combined chairperson-CEO/MDdue to lack of time;
  5. increasing the possibility that the chairperson and CEO/MD posts will be assumed by individuals possessing the skills and experience appropriate for those positions;
  6. creating a board environment that is more egalitarian and conducive to debate”

Considering the aforesaid recommendations of Uday Kotak Committee on Corporate Governance, the provisions of Regulations, 2015 were amended through the SEBI (LODR) (Amendment) Regulations, 2018 (“Amendment Regulations”) brought in force from 9th May, 2018. By virtue of the said regulations a new sub-regulation was inserted in regulation 17 which states:

“(1B). With effect from April 1, 2020, the top 500 listed entities shall ensure that the Chairperson of the board of such listed entity shall –

(a) be a non-executive director;

(b) not be related to the Managing Director or the Chief Executive Officer as per the definition of the term “relative” defined under the Companies Act, 2013:

Provided that this sub-regulation shall not be applicable to the listed entities which do not have any identifiable promoters as per the shareholding pattern filed with stock exchanges.

Explanation-The top 500 entities shall be determined on the basis of market capitalisation, as at the end of the immediate previous financial year.”

The new sub-regulation inserted provides that the chairman of the board has to be mandatorily a Non-executive director and should not be related to the MD or CEO of the Company. Here, the Amendment Regulations, has provided more stringent requirement that the Chairman can definitely not be a executive director i.e. MD or CEO but also he should not be a relative i.e. spouse, children, mother, father etc. of the MD/CEO as per the provisions of section 2(77) of the Act, 2013. The said amendment shall be applicable from 1st April, 2020 on top 500 listed companies. However, the question which arises here is that whether pursuant to this regulation every listed company is required to have a permanent chairman of the Board. The recommendation of the Uday Kotak Committee does not specify such an intention, however, the same is subject to interpretation of the reader. However, in our view, the sub-regulation requires a Company to have a non-executive chairman if the Company has one.

The separation of chairman and CEO or Managing Director is coming from Sarbanes Oxley, and thereafter has been adopted in corporate governance codes of several jurisdictions, including the UK. Its need and relevance to Indian context is quite limited. The term “Chairman” is a decorative position in India. Unlike global boards, chairman does not hold any substantial powers, except the power to convene board and general meetings. If chairmanship is a position without any substantial powers, and therefore, without any special responsibilities, not much can be hoped to be achieved by splitting the two. Hence, in our view, separation of role of MD and chairman shall not have any impact as the requirement may be complied by companies by executive directors giving up the chairman’s role to an independent director and control the company in other ways. Therefore, such requirement may result in a cosmetic change to corporate governance without any intent.

Comparison of role of Chairman in India and in other countries

In general, the role of a Chairperson in India, is to chair the meeting and head the Board or committee, as the case may be. Considering the provisions of CA, 2013, the Chairperson has been empowered to deliver various functions, which in a nutshell can be termed as the role of a Chairperson which inter-alia includes:

  1. ensuring that the meetings of the Company are conducted in a fair manner and look after the meeting related compliances in terms of his role to conduct or declare or answer on the related matters; and
  2. casting vote in case of deadlock of management (if explicitly provided in the Articles of Association of the Company)

In India, the role of chairman has been limited to conducting meetings. However, codes of various countries bestows a wider responsibility on the chairperson which includes shareholder engagement, ensuring effectiveness of Board relations and understanding of the organisation’s financial position, strategic performance, operations on the chairman of Company etc. Further, the corporate governance codes internationally prescribes bifurcation of role of CEO/MD and the role of Chairman.

 

Sl. No. Country Who can be chairman? Powers and responsibilities of Chairman

 
1. United Kingdom As per UK Corporate Governance Code:

 

The chair should be independent on appointment when assessed against the circumstances set out in Provision 10. The roles of chair and chief executive should not be exercised by the same individual. A chief executive should not become chair of the same company. If, exceptionally, this is proposed by the board, major shareholders should be consulted ahead of appointment. The board should set out its reasons to all shareholders at the time of the appointment and also publish these on the company website.

 

Also, United Kingdom’s Cadbury Committee in the Report of the Committee on the Financial Aspects of Corporate Governance (1992)

 

 Given the importance and the particular nature of the chairmen’s role, it should in principle be separate from that of the chief executive. If the two roles are combined in one person, it represents a considerable concentration of power.

 

 

 The responsibility of chairman are as follows:

 

a)     To seek regular engagement with major shareholders in order to understand their views on governance and performance against the strategy.

b)     To receive written statement from NEDs on their resignation and circulate to the same to the board.

c)     Leads the board and is responsible for its overall effectiveness in directing the company.

d)     Facilitates constructive board relations and the effective contribution of all non-executive directors, and ensures that directors receive accurate, timely and clear information.

e)     Considers having a regular externally facilitated board evaluation.

 
2. Australia The Corporate Governance Code:

 

The Governance Principles recommend that a majority of the board should be independent (non-executives directors that are free from the relationships that may impede independent judgement) and that the chair be an independent director.

 

 

 The role of the chair is not defined in the Corporations Act 2001, thus many functions of the chair are customary rather than formalised by law.

a)    facilitating proper information flow to the board;

b)    facilitating the effective functioning of the board including managing the conduct, frequency and length of board meetings;

c)    communicating the views of the board, in conjunction with the CEO, to the organisation’s security holders, broader stakeholders and to the public.

d)    setting the agenda for the matters to be considered by the board;

e)    seeking to ensure that the information provided to the board is relevant, accurate, timely and sufficient to keep the board appropriately informed of the performance of the organisation and of any developments that may have a material impact on the organisation or its performance;

f)     Seeking to ensure that the board as a whole has the opportunity to maintain adequate understanding of the organisation’s financial position, strategic performance, operations and affairs generally and the opportunities and challenges facing the organisation;

g)    Overseeing and facilitating board, committee and board member evaluation reviews and succession planning;
3. New Zealand Corporate Governance in New Zealand- Principles and guidelines:

 

We recommend the chair be independent. No director should simultaneously be a chair and chief executive of the entity (or equivalent). Only in exceptional circumstances should the chief executive go on to become the chair.

The chair also has a pivotal role between the chief executive and the board. The balance between these roles is important. It works best if the roles of chair and chief executive (or equivalent) are clearly separated, and the chair is an independent director. In general, the chief executive should not go on to become the chair. Only in special circumstances should this occur, for example where an individual has the skills, knowledge and experience not available elsewhere to the entity. These circumstances should be fully explained to investors and stakeholders.

 

 The duties of the Chairman are as follows:

 

a)     fostering a constructive governance culture and ensuring directors and management apply appropriate governance principles.

b)     promoting cooperation, mediating between different perspectives, and leading informed debate and decision-making

c)     leading the process of evaluation and review of the board’s performance.

d)     exercises pivotal role in creating balance between the chief executive and the board.
4 NYSE NYSE- Corporate Governance Guide

 

We believe that the role of the Chief Executive Officer and management is to run the business of the company and the role of the board of directors is to oversee management. We believe given these different roles and responsibilities, leadership of the board should be separated from leadership of management.

 

 The Chairman shall have such duties and powers as set forth in the Company’s By-Laws or as shall otherwise be conferred upon the Chairman from time to time by the Board.

Conclusion

To conclude, we may say that the requirement of appointing a chairman and their role is very subjective. Whereas, the Act, 2013 and the Listing Regulations does not mandatorily require a Company to have a permanent chairman on the board, however, the provisions require the chairman to be independent i.e. non-executive and his office should be separated from that of a CEO/MD. In this regard, whether the intent of the Amendment Regulations is to mandate the appointment of chairman or not is subject to interpretation and clarification. Recently, companies are receiving notices from stock exchange for not complying with the requirement of Regulation 17(1)(b) i.e. not having adequate number of independent directors in cases where companies do not have a permanent chairman on Board. Therefore, though the requirement is not mandatory, companies should exercise caution while constituting its Board.